Liquidity Risk

Definition

Liquidity Risk is a broad term that in general captures the ability of an agent to transact (sell or buy) non-cash assets in exchange for cash within a desired time-frame. In the context of Risk Management liquidity risk has two major sub-categories, Market Liquidity Risk and Funding Liquidity Risk

Market Liquidity Risk

In the context of market risk management, liquidity risk refers to the ability of market participants to acquire or liquidate assets traded in that market with minimal transaction costs. This subtype of liquidity risk is a characteristic of the market itself (technical infrastructure, depth of participation, information asymmetries etc.)

Funding Liquidity Risk

In the context of funding risk management, liquidity risk refers to the ability of e.g., a bank's treasury department to manage the cashflows scheduled for the portfolio of assets and liabilities without undue costs. Hence this variation of liquidity risk has, in addition to the external liquidity constraints, strong dependence on the portfolio itself.

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