medium · FRM Part 2 Liquidity & Treasury Risk
An institutional fund manager calculates the liquidity-adjusted VaR (LVaR) for a large corporate bond position using the exogenous-spread approach. During a period of market stress, the bid-ask spread mean increases by 50% and its volatility doubles.
What is the impact on the liquidity 'uplift' over standard VaR?
- The uplift increases more than one-for-one due to the 'stress multiplier' k applied to the increased spread volatility.
- The uplift decreases because the portfolio's diversification benefit offsets the rising spreads across positions.
- The uplift only increases if the liquidation strategy is 'endogenous', meaning trade size alone moves the market's mid-price level.
- The uplift remains constant because standard VaR already accounts for the position's expected liquidation horizon and depth.
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