Premium
The Impact of Liquidity Risk: A Fresh Look *
Author(s) -
STANGE SEBASTIAN,
KASERER CHRISTOPH
Publication year - 2011
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/j.1468-2443.2010.01113.x
Subject(s) - market liquidity , liquidity risk , liquidity premium , accounting liquidity , liquidity crisis , econometrics , financial risk management , economics , order (exchange) , financial economics , business , monetary economics , risk management , finance
This paper takes a fresh look at the importance of liquidity risk using a comprehensive liquidity measure, weighted spread, in a Value‐at‐Risk (VaR) framework. The weighted spread measure extracts liquidity costs by order size from the limit order book. Using a unique, representative data set of 160 German stocks over 5.5 years, we show that liquidity risk is an important risk component. Actually, liquidity risk is increasing the total price risk by over 25%, even at 10‐day horizons and for liquid blue chip stocks and especially in larger, yet realistic order sizes beyond €1 million. When correcting for liquidity risk, it is commonly assumed that liquidity risk can be simply added to price risk. Our empirical results show that this is not correct, as the correlation between liquidity and price is non‐perfect and total risk is thus overestimated.