Framework of Liquidity Risk Assessment for JP Morgan Private Bank $500B Fund of Funds Multi-Asset Portfolio Construction & Optimization. “With market risk and credit risk, you could lose a fortune. With liquidity risk, you could lose the bank!”. LIQUIDITY. MODEL. Liquidity Risk / Cost.
“With market risk and credit risk, you could lose a fortune. With liquidity risk, you could lose the bank!”
Idiosyncratic Risk (Endogenous) Market Risk (Exogenous)
Funding Liquidity Risk
Capture Diversity of Risk Assets
f (size, complex, convertible)
Measures for Various Asset Classes
Preserve Core Parameters for Aggregates
Time Horizon Maturity Duration Convexity
Volatility Autocorrelations Returns Stress Tests Price Discovery
"Market risk can hurt you, but liquidity risk can kill you."
"Liquidity is a great metaphor, but we still don't have an unambiguous definition of it."
LVaR = position ($) *
[-drift (%) + volatility *deviate + LC]; 0.5*spread
" No single measure captures the various aspects of liquidity in financial markets."
“Comparing individual assets’ liquidities is problematic because one asset could be more liquid along one dimension of transaction costs while the other is more liquid in a different dimension.”
Jarrow & Protter (2005)
Stange and Kaserer (2008)
Giot & Gramming (2005)
Bangia et al. (2001)
"No bank can ever afford to hold enough liquidity during normal times to be able to survive a severe or prolonged funding disruption."
"Liquidity risk today is where credit risk was 10 years ago."
" In times of financial crisis, asset prices in some markets may reflect the amount of liquidity available in the market rather than the future earning power of the asset."
Post-2008 Trends Requiring Research Advances forWall Street Firm Multi-Asset Portfolio of 16 Asset Classes
" People have known since Mandelbrot in 1963 that returns are not normally distributed."
"I'd just caution you that models are backward-looking. The future isn’t the past."
Stress Testing Scenarios Minimize Model Risk
"Normality has been an accepted wisdom in economics and finance for a century or more. Yet in real-world
systems, nothing could be less normal than normality. Tails should not be unexpected, for they are the rule."
MODELS / MEASURES
"It is truly an art to build a long-term robust quantitative model that will perform well out-of-sample and through several different types of market environments.”
MODELS / MEASURES
"I think you should be ambitious about your models, and push them as far as you can, but you need to be aware they will fail - and under what circumstances.”