medium · FRM Part 2 Liquidity & Treasury Risk
An institutional scenario describes a bank holding a massive position in a thinly traded emerging market bond. The position is 20 times the average daily volume (ADV) of the bond.
When calculating 'Liquidity-Adjusted VaR' (LVaR), which component is likely to be the most significant error if ignored?
- The 'ghost effect' from a past severe liquidity crisis still sitting inside the look-back window.
- The diversification benefit assumed between the bond's interest-rate risk and its own separate liquidity risk.
- Exogenous liquidity risk, since the bid-ask spread is typically wide for thinly traded emerging-market debt issues.
- Endogenous liquidity risk, as the liquidation of the position will move the market price against the bank.
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