Liquidity Stress Testing in Asset Management - Part 2. Modeling the Asset Liquidity Risk

86 Pages Posted: 25 May 2021

See all articles by Thierry Roncalli

Thierry Roncalli

Amundi Asset Management; University of Evry

Amina Cherief

Amundi Institute

Fatma Karray-Meziou

Amundi Asset Management

Margaux Regnault

National Institute of Statistics and Economic Studies (INSEE) - National School for Statistical and Economic Administration (ENSAE)

Date Written: May 5, 2021

Abstract

This article is part of a comprehensive research project on liquidity risk in asset management, which can be divided into three dimensions. The first dimension covers liability liquidity risk (or funding liquidity) modeling, the second dimension focuses on asset liquidity risk (or market liquidity) modeling, and the third dimension considers the asset-liability management of the liquidity gap risk (or asset-liability matching). The purpose of this research is to propose a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers. The review of the academic literature and professional research studies shows that there is a lack of standardized and analytical models. The aim of this research project is then to fill the gap with the goal of developing mathematical and statistical approaches, and providing appropriate answers.

In this second article focused on asset liquidity risk modeling, we propose a market impact model to estimate transaction costs. After presenting a toy model that helps to understand the main concepts of asset liquidity, we consider a two-regime model, which is based on the power-law property of price impact. Then, we define several asset liquidity measures such as liquidity cost, liquidation ratio and shortfall or time to liquidation in order to assess the different dimensions of asset liquidity. Finally, we apply this asset liquidity framework to stocks and bonds and discuss the issues of calibrating the transaction cost model.

Keywords: Asset liquidity, stress testing, bid-ask spread, market impact, transaction cost, participation rate, power law, liquidation cost, liquidation ratio, liquidation shortfall, time to liquidation

JEL Classification: C02, G32

Suggested Citation

Roncalli, Thierry and Cherief, Amina and Karray-Meziou, Fatma and Regnault, Margaux, Liquidity Stress Testing in Asset Management - Part 2. Modeling the Asset Liquidity Risk (May 5, 2021). Available at SSRN: https://ssrn.com/abstract=3849496 or http://dx.doi.org/10.2139/ssrn.3849496

Thierry Roncalli (Contact Author)

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

University of Evry ( email )

Boulevard Francois Mitterrand
F-91025 Evry Cedex
France

Amina Cherief

Amundi Institute ( email )

90 Boulevard Pasteur
Paris, 75015
France

Fatma Karray-Meziou

Amundi Asset Management

90 Boulevard Pasteur
Paris, 75015
France

Margaux Regnault

National Institute of Statistics and Economic Studies (INSEE) - National School for Statistical and Economic Administration (ENSAE)

92245 Malakoff Cedex
France

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