Financial Market Liquidity Risk

Abstract

This article takes the form of a review of the literature addressing the subject of liquidity risk applied to financial markets. First, we focus through a review of previous writings on the importance of liquidity risk which emerged after the last global financial crisis and which brought to light major weaknesses in the management and functioning of the financial system. We will first study the notion and the concept of liquidity and then present the indicators of systemic liquidity risk in financial markets. In order to take into account the systemic dimension of liquidity risk and ensure the proper development of tools and models capable of measuring liquidity risk, we will pose the following question: what variables should we take into account, in particular when we focus on liquidity risk? The choice of gross liquidity indicators is of crucial importance for the construction of the systemic indicator, because these must make it possible to capture key elements of the evolution of the liquidity of the financial markets. Three sub-indices, which reflect liquidity pressures in these three representative market segments (the equity and corporate market, the bond market and the money market), are aggregated into the liquidity risk variable in the same way as individual risks in order to quantify the overall risk. The aggregation takes into account the time-varying cross-correlations between the sub-indices, using a multivariate GARCH approach. This is able to capture abrupt changes in correlations.

JEL classification: G1 G32

Article type: Theoretical Research