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Title:Why and how to integrate liquidity risk into a VaR-framework PDF Logo
Authors:Stange, Sebastian
Kaserer, Christoph
Issue Date:2008
Series/Report no.:CEFS working paper series 2008-10
Abstract:We integrate liquidity risk measured by the weighted spread into a Value-at-Risk (VaR) framework. The weighted spread measure extracts liquidity costs by order size from the limit order book. We show that it is precise from a risk perspective in a wide range of clearly defined situations. Using a unique, representative data set provided by Deutsche Boerse AG, we find liquidity risk to increase traditionally-measured price risk by over 25%, even at standard 10-day horizons and for liquid DAX stocks. We also show that the common approach of simply adding liquidity risk to price risk substantially overestimates total risk because correlation between liquidity and price is neglected. Our results are robust with respect to changes in risk measure, to sample periods and to effects of portfolio diversification.
Subjects:asset liquidity
price impact
weighted spread
Xetra Liquidity Measure (XLM)
Value-at-Risk
market liquidity risk
JEL:G11
G12
G18
G32
Document Type:Working Paper
Appears in Collections:CEFS Working Paper Series, Center for Entrepreneurial and Financial Studies, Technische Universität München

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