Liquidity Risk

Authored by: Thierry Roncalli

Handbook of Financial Risk Management

Print publication date:  April  2020
Online publication date:  April  2020

Print ISBN: 9781138501874
eBook ISBN: 9781315144597
Adobe ISBN:


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Liquidity is a long-standing issue and also an elusive concept (Grossman and Miller, 1988). It cannot be observed directly, because it measures the ease of trading an asset. More precisely, it measures the asset’s ability to be sold as soon as possible without causing a significant price movement. This is why it is difficult to capture liquidity in a single measure (bid-ask spread, trading volume, etc.). Moreover, liquidity risk generally refers to two related notions: market liquidity and funding liquidity. Market liquidity concerns assets. For instance, the most liquid asset is cash because it can always be used easily and immediately. Many stocks and sovereign bonds are considered fairly liquid, because they can be sold in the day. On the contrary, private equity and real estate are less liquid assets, because it can take months to sell them. Funding liquidity concerns asset liability mismatch due to liquidity and maturity transformation activities. According to Drehmann and Nikolaou (2013), funding liquidity is defined “as the ability to settle obligations with immediacy. It follows that, a bank is illiquid if it is unable to settle obligations in time”. The concept of funding liquidity is of course important for banks, but also for other financial entities (insurance companies, asset managers, hedge funds, etc.).

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