New research paper available : "Liquidity risk in fixed income markets"
Natixis AM’s Fixed Income investment division is pleased to present its latest research publication. Composed by the Quantitative Research and Analysis team, the document highlights the theme of liquidity risk in fixed income markets.
“Market risk and liquidity risk are by far the main sources of uncertainty affecting a portfolio’s future P&L. While the former can be explained by uncertainty regarding price fluctuations, the latter is incurred when trading assets. Illiquidity increases with the size of the position. It occurs over some short term but vanishes over a longer horizon. Typically a security held to maturity has no liquidity cost.
However, unlike other risk factors, liquidity risk cannot be diversified. For example, one cannot offset a given level of liquidity “exposure” by going short an illiquid security. More generally, no known liquidity-based derivatives could hedge this particular risk. Indeed, in stressed markets, bid rather than mid prices prevail.
In this paper, after a brief survey of the financial theory on liquidity risk, we examine its main characteristics, its measures and drivers as well as its preeminent role in the development of crisis and the burst of bubbles.”