MARKET LIQUIDITY RISK: A SCENARIO BASED APPROACH
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Overview: This paper explains the StatPro approach for measuring Liquidity Risk. The traditional problem of Liquidity Risk is that the data needed for calibrating these models is only available for liquid instruments, trading on a regular basis and for which books of bid/ask and volumes are available. For this reason the current approaches to measuring Liquidity Risk fail providing any indication for the most opaque and illiquid instruments, or where the measurement of Liquidity Risk is mostly needed. StatPro has introduced a new approach based on liquidity scenarios, which is universal, because it covers potentially any financial asset, from equities, to bonds, to OTC derivatives under a homogeneous and consistent approach. The Liquidity Risk measure is divided into six different components. The most important component re-builds, with a quantitative approach based on observed market data, the fair value bid and asks of all the financial instruments that can be priced via an arbitrage-free pricing function, providing a solid and consistent benchmark of Liquidity Risk.