The Budapest Liquidity Measure and its Application Liquidity Risk in VaR Measures

Abstract

We introduce the Budapest Liquidity Measure (BLM) and one of its possible applications in the field of risk management. BLM is a weighted spread measure, it represents the implicit costs of trading, which arise from the fact that actual trading is not executed at the mid-price. Traditional VaR measures cover only the risk of the changing mid-price, they ignore the liquidity risk arising from the buying and selling of a position. With the use of BLM we show, how to integrate liquidity risk into the VaR-framework. While our method has already been introduced, it has never been tested on the Hungarian market. We also point out several areas of possible improvement. In our analysis we use the data of the stocks of the Budapest Stock Exchange, and find that even in the case of the most liquid stocks and smallest positions, the daily VaR measures can rise by up to 4% if we take the liquidity risk into account.

Keywords: liquidity, value at risk, financial markets, Budapest Stock Exchange

JEL Classification: D81, E47, G11, G14, G15