A Fully Integrated Liquidity Market Risk Model

Attilio Meucci: Going beyond the simple bid—ask spread overlay for a particular value at risk, we introduce a framework that integrates liquidity risk, funding risk, and market risk.


Attilio Meucci

Research Associate, EDHEC-Risk Institute

We overlay a whole distribution of liquidity uncertainty on future market risk scenarios and we allow the liquidity uncertainty to vary from one scenario to another, depending on the liquidation or funding policy implemented. The result is one easy-to-interpret, easy-to-implement formula for the total liquidity-plus-market-risk profit and loss distribution. Using this formula we can stress-test different market risk P&L distributions and different scenario-dependent liquidation policies and funding policies; compute total risk and decompose it into a novel liquidity-plus-market risk formula; and define a liquidity score as a monetary measure of portfolio liquidity. Our approach relies on three pillars: first, the literature on optimal execution, to model liquidity risk as a function of the actual trading involved; second, an analytical conditional convolution, to blend market risk and liquidity/funding risk; third the Fully Flexible Probabilities framework, to model and stress-test market risk even in highly non-normal portfolios with complex derivatives. Our approach can be implemented efficiently with portfolios of thousand of securities. The code for the case study is available at http://www.symmys.com/node/350.
A Fully Integrated Liquidity Market Risk Model...
(-1.00 B)
Type: Working paper
Date: le 12/12/2012
Extra information : For more information, please contact EDHEC Research and Development Department [ research@drd.edhec.edu ]
Research Cluster : Finance

See Also

How To: 8 tips for choosing your MBA
- 08-03-2019
Embarking on an MBA can be life-changing. It’s also an investment on many levels; you’...
European Excellence and Make an Impact Scholarships available for September 2019 Intake
- 07-03-2019
Two New Scholarship Programmes for 2019 EDHEC Business School has added two new Global...
Paper co-authored by Lionel Martellini and Vincent Milhau wins the 20th Annual Bernstein Fabozzi/Jacobs Levy Award for Outstanding Article from the Journal of Portfolio Management
- 04-03-2019
The paper, entitled "Proverbial Baskets Are Uncorrelated Risk Factors! A Factor-Based...
One life, one journey - Hard work and dedication pay off
- 04-03-2019
Temitope Ayorinde, a 2018 Master in Management, Business Management graduate, left his...