November 08, 2010

StatPro Inc. designed a new approach to measuring liquidity risk, which is now available as StatPro Seven, a new module in the latest version of StatPro Risk management.

StatPro Seven is an integrated, SaaS-based portfolio analytics platform that provides performance measurement, attribution analysis, risk management, GIPS composites, governance & compliance, analytics reporting and financial index data services, all from a single platform.

According to the company’s press statement, StatPro has designed an innovative approach to measuring market liquidity risk that does not rely only on observed bid, ask and volumes. Instead, factors such as market capitalization, the percentage of ownership of a stock and the size of an issue for a fixed income instrument are taken into account.

Liquidity risk refers to the risk of losing money when you suddenly liquidate one or more positions in your portfolio. The loss comes from selling the positions at a lower price than the one at which those positions are marked-to-market. “While innovations in the area of market risk have been very active in recent years – for example, introducing the concept of Value at Risk — little exists on liquidity risk. The reason is that while measuring market risk you can create models that are calibrated with market data, you cannot do the same for liquidity risk,” said Dario Cintioli, Global Head of Risk of StatPro, in the same press statement. “In calibrating a liquidity risk model, you need access to the bid, ask and volume information,” Cintioli continued, “The problem is that this information is only available for liquid issues. Whatever model you invent, you will always lack the basic information to calibrate it for the instruments that present most of your liquidity risk. We call this the ‘liquidity risk paradox’.

StatPro’s software facilitates the selection of the appropriate liquidity risk scenario and the computation of the expected loss for liquidity risk. The view includes a breakdown of the liquidity risk loss across various components, according to the release. The user can select one scenario and build a ‘tree’ of criteria for breaking down the liquidity risk contribution at each hierarchy level, down to single asset composition. The risk manager can drill down through every component of liquidity risk, discovering how much is coming and from where, without any previous knowledge of the portfolio. This tool enables the risk manager to ‘X-ray’ the liquidity risk of the portfolio, spotting any challenging situations. "We have solved the paradox of measuring market liquidity risk when trading volume and market price information is not available. As with all our risk analyses, liquidity risk can be run at single asset level, portfolio level, portfolio versus benchmark and as an aggregation of several portfolios. The latter option is critical to liquidity risk, as the percentage of ownership of one stock can be negligible when measured by portfolio, but can become relevant at ‘firm’ level," concludes Cintioli.

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Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in ...