Author: Timotheos AngelidisPublisher:
ISBN:
Category :
Languages : en
Pages : 20
Book Description
This paper proposes a method of calculating a Liquidity Adjusted Value-at-Risk (L-VaR) measure. The traditional approaches that have been implemented assume that the financial markets are perfect and hence an investor can either buy or sell any amount of stock without causing significant price changes. However, this conjecture is not a realist one as most of the markets, especially the emerging ones, are illiquid. In the attempt to create a L-VaR measure that accounts for the spread variation, we estimate the components of the bid-ask spread in order to calculate accurately both the endogenous and the exogenous liquidity risk. Under the new framework, the liquidation price of a position will not be the midpoint of the spread, but at least the bid price and therefore the calculated Value-at-Risk number will be more realistic. We extend the Madhavan et al. (1997) model by incorporating the traded volume and find out that both the adverse selection component and the L-VaR measure exhibit a U-shape pattern throughout the day, while the percent of risk that is attributed to liquidity displays an inverse U-shape pattern. Finally, at higher confidence level, the liquidity component of the high-priced, high-capitalization stocks represents 3.40% of the total market risk, while for the low capitalization securities it equals to 11% and therefore cannot be neglected.