The leading knowledge platform for the financial technology industry
The leading knowledge platform for the financial technology industry

A-Team Insight Blogs

RiskMetrics’ Acerbi Talks up Development of Mark to Liquidity Modelling

Mark to market may be top of the regulatory and industry agenda at the moment, but according to RiskMetrics researcher Carlo Acerbi, mark to liquidity could well be the next big thing in the risk management world. Speaking at Thomson Reuters’ recent Global Pricing Forum in London, Acerbi elaborated on the development of a model to more accurately measure liquidity risk on a given holding.

Acerbi noted that a lot of work in the industry thus far has been focused on concepts such as liquidity premiums and global liquidity indices to determine overall capital market liquidity. However, when it comes down to the level of a portfolio, there is still a lot of work to be done to determine how each component is affected by liquidity risk, and this is where the concept of mark to liquidity comes into play. He believes this framework may be able to help to provide a precise figure for portfolio liquidity risk as a function of the market variables that explain and drive it.

Mark to liquidity is therefore a framework to provide quantitative data on how much a given portfolio is affected by liquidity risk, or how it affects other factors such as value at risk (VaR). In order to explain the theory, Ascerbi elaborated that portfolio liquidity risk, which is at the heart of the model, is the implicit cost faced by a portfolio subject to liquidity or risk constraints in an illiquid market environment. These constraints could be risk or trading limits or margin requirements or other similar limits on a portfolio, all of which add up to what Acerbi calls an overall liquidity policy.

The mark to liquidity framework is based upon the combination of these portfolio constraints and market illiquidity. The calculation therefore quantifies liquidation costs at the level of this liquidity policy in a similar manner to mark to market measures. The strategy behind the framework is not to invent a new liquidity risk measure, according to Acerbi, but to change the definition of portfolio value. In mark to liquidity, he contends that potential liquidation costs due to the commitment to a given liquidity policy (ergo the liquidity structure of the market and the constraints of the portfolio) are taken into account.

“It is no longer a linear function where two values will add up to the sum of their parts, as in VaR calculations. The more granular the portfolio, the less the liquidity risk,” said Acerbi. “These things are not reflected in standard portfolio valuation and this is why the market needs a measure such as mark to liquidity.”

Given the regulatory bent towards forcing firms to more accurately measure their liquidity risk exposure, this model may prove popular as firms seek to roll out new analytics systems in a space that has until now been largely overlooked in terms of the risk function. However, it is early days and feedback is needed on how the models work in practice.

Related content

WEBINAR

Upcoming Webinar: Evolution of data management for the buy-side 2021

Date: 27 May 2021 Time: 10:00am ET / 3:00pm London / 4:00pm CET Duration: 50 minutes The buy-side faced a barrage of regulation in 2020 and is now under pressure to make post-Brexit adjustments and complete LIBOR transition by the end of 2021. To ensure compliance and ease the burden of in-house data management, many...

BLOG

GLEIF Details Technologies Underlying Digital Version of LEI, the Verifiable LEI

The Global Legal Entity Identifier Foundation (GLEIF) has published issuance and technical infrastructure models for the verifiable LEI (vLEI) system it introduced back in December 2020. The vLEI is a secure digital attestation of a conventional LEI and is designed to extend the use of the identifier and, ultimately, enable instant and automated identity verification...

EVENT

TradingTech Summit London

The TradingTech Summit in London brings together European senior-level decision makers in trading technology, electronic execution and trading architecture to discuss how firms can use high performance technologies to optimise trading in the new regulatory environment.

GUIDE

FATCA – The Time to Act is Now

The US Foreign Account Tax Compliance Act – aka FATCA – raised eyebrows when its final regulations requiring foreign financial institutions (FFIs) to report US accounts to US tax authorities were published last year. But with the exception of a few modifications, the legislation remains in place and starts to comes into force in earnest...