Liquidity-Adjusted Market Risk Measures with Stochastic Holding Period

11 Pages Posted: 21 Sep 2010 Last revised: 22 Oct 2010

See all articles by Damiano Brigo

Damiano Brigo

Imperial College London - Department of Mathematics

Claudio Nordio

illimity Bank

Date Written: October 20, 2010

Abstract

Within the context of risk integration, we introduce in risk measurement stochastic holding period (SHP) models. This is done in order to obtain a 'liquidity-adjusted risk measure' characterized by the absence of a fixed time horizon. The underlying assumption is that - due to changes on market liquidity conditions - one operates along an 'operational time' to which the P&L process of liquidating a market portfolio is referred.

This framework leads to a mixture of distributions for the portfolio returns, potentially allowing for skewness, heavy tails and extreme scenarios. We analyze the impact of possible distributional choices for the SHP. In a multivariate setting, we hint at the possible introduction of dependent SHP processes, which potentially lead to non linear dependence among the P&L processes and therefore to tail dependence across assets in the portfolio, although this may require drastic choices on the SHP distributions. We also find that increasing dependence as measured by Kendall's tau through common SHP's appears to be unfeasible. We finally discuss potential developments following future availability of market data.

Keywords: Liquidity Risk, Random Holding Period, Systemic Risk, Basel Agreement, Value at Risk, Expected Shortfall, Stochastic Holding Period, Variance Normal Mixture, Tail Dependence, Heavy Tailed Distributions

JEL Classification: C15, C16, G10, G18

Suggested Citation

Brigo, Damiano and Nordio, Claudio, Liquidity-Adjusted Market Risk Measures with Stochastic Holding Period (October 20, 2010). Available at SSRN: https://ssrn.com/abstract=1679698 or http://dx.doi.org/10.2139/ssrn.1679698

Damiano Brigo (Contact Author)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.imperial.ac.uk/people/damiano.brigo

Claudio Nordio

illimity Bank ( email )

Milano
Italy

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