Market liquidity risk

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As market liquidity risk is liquidity risk of a market participant understood that assets , in particular financial instruments , because of the low market liquidity and market depth of a market to a lesser than the expected market price can be sold or not.

General

The market liquidity risk mainly affects financial markets such as the money market or capital market ( stock market , bond market or foreign exchange market ). If there is a narrow market due to shocks , excess supply or gaps in demand as market imbalances , sellers willing to sell face the risk of not being able to sell their trading objects (such as stocks , bonds , derivatives or foreign exchange ) at the expected fair value , but at a lower value current market or price value or not at all. As a result, any risk position (an exposure ) can only be closed under financially less favorable conditions than expected or not at all.

In contrast, a liquid market is characterized by the fact that trading objects can be sold at or near fair value at any time and immediately. Even liquid markets can get into a liquidity crisis during their market development , so that the liquidity of trading objects can be restricted.

causes

The stock exchanges are less affected by the market liquidity risk, but the OTC trading is all the more affected . The cause here are the market structures and market transparency , which do not function optimally in the case of an existing market liquidity risk. Increasing duration and specificity of the trading objects or financial contracts make their saleability more difficult (liquidity).

Market structure

Risk drivers for market liquidity risk are in particular

They can occur in isolation or in combination.

In terms of market liquidity risk, a distinction can be made between exogenous and endogenous market liquidity risk. The exogenous market liquidity risk is independent of the trading market participant and therefore depends solely on external factors. The main thing is that the bid-ask spread (at a constant price) increases and therefore a deal is only possible at a lower price. An unfavorable change in the price as a whole would not be attributable to the market liquidity risk, but to the market price risk .

This no longer applies if the movement in the market price is due to the trading person's attempts to close his position. For example, an investor's attempt to sell a large block of shares can cause that stock to fall in price. The investor then suffers a loss because he can only sell his shares at a lower price (“package discount”). This form of market liquidity risk can be described as endogenous market liquidity risk , as it also depends on internal factors. The less receptive (liquid) the market, the larger the position and the faster it is liquidated, the more it must be expected that the position can only be closed under unfavorable conditions.

Demarcation

Market liquidity risk is a financial risk and is sometimes viewed as part of market price risk. However, a strict distinction must be made between market price risk and market liquidity risk. An unfavorable change in the market price as a whole is not a market liquidity risk, but a market price risk. This no longer applies if the movement in the market price is due to the seller's attempts to close his position. For example, this includes an investor's attempt to sell a large block of shares. The stock market price of this share is likely to fall due to the generally low market volume . This form of market liquidity risk is an endogenous market liquidity risk because it depends on internal factors. The less receptive (liquid) the market, the larger the position and the faster it is liquidated, the more it must be expected that the position can only be closed under unfavorable conditions. This market illiquidity also has an impact on pricing, for example in the case of the bid-ask spread , so that this is at least partially part of the market price risk because there are interdependencies between the market risk as price risk and the market liquidity risk.

Measurement

The external market liquidity risk can be taken into account when modeling the normal market price risk. In the literature, there are proposals to model possible future changes in the bid-ask spreads stochastically and to integrate this modeling into the normal value at risk models for the market price risk .

One way to quantify internal market liquidity risk is to estimate the impact on market price that closing a large position would have. This requires information on the price elasticity of the instrument concerned on the financial markets. A slow closing of a position, ie a successive liquidation over a longer period of time, reduces the negative influence of the endogenous market liquidity risk, but increases the risk of losses from the market price risk. An investor can try to estimate these two parameters (liquidation costs and risk of loss) depending on the liquidation time and use them to derive an optimal liquidation strategy.

literature

  • Arnaud Bervas: Market liquidity and its incorporation into risk management . Banque de France Financial Stability Review No. May 8, 2006.
  • Wagner, Schmeling, Meyer, Kemp (KPMG): Risk Factor Liquidity in Credit Institutions Research in Capital Markets and Finance Working Paper 2002-3, LMU Munich.

Individual evidence

  1. ^ Verlag Die Wirtschaft (Ed.), Betrieb und Wirtschaft , Volume 57, 2003, p. 532
  2. ↑ Hermann F Bährle, risk controlling the use of derivative financial instruments in the investment of insurance companies , 1997, p 20
  3. ^ Rajna Gibson / Heinz Zimmermann, The Benefits and Risks of Derivative Instruments , in: Finanzmarkt und Portfolio-Management, 1996, p. 34
  4. ↑ Anil Bangia / Francis Diebold / Til Schuermann / John D. Stroughair, Liquidity Risk, with implications for traditional market risk measurements , Wharton School Working Paper 99-06, 1999. Quoted here from Arnaud Bervas, Market liquidity and its incorporation into risk management . Banque de France Financial Stability Review No. 8, May 2006, and the KPMG study 2002
  5. ↑ Christoph Meyer, Value at Risk for Credit Institutes , 1999, p. 79