StatPro discovers way to measure liquidity risk for hedge fund portfolio

StatPro has discovered what it said is a solution to the liquidity risk paradox. Its approach does not rely on observed bid, ask and volumes.

Instead, factors such as market capitalisation, the percentage of ownership of a stock and the size of an issue for a fixed income instrument are taken into account.

“While innovations in the area of market risk have been very active in recent years – for example, introducing the concept of value at risk – little exists on liquidity risk,” explained Dario Cintioli, global head of risk of StatPro.

When measuring market risk it is possible to create models that are calibrated with market data. However, it is not possible to do the same for liquidity risk, he added.
 
To calibrate a liquidity risk model access to the bid, ask and volume information is needed. But this information is only available for liquid issues. Whatever model is used, it will lack the basic information to calibrate for the instruments that present most liquidity risk. This is what StatPro calls the ‘liquidity risk paradox’.
 
StatPro’s software facilitates the selection of the appropriate liquidity risk scenario and the computation of the expected loss for liquidity risk. The view includes a breakdown of the liquidity risk loss across various components.

The user can select one scenario and build a ‘tree’ of criteria for breaking down the liquidity risk contribution at each hierarchy level, down to single asset composition. The risk manager can drill down through every component of liquidity risk, discovering how much is coming and from where, without any previous knowledge of the portfolio.
 
StatPro is a provider of portfolio analysis and asset valuation services for the global asset management industry.