A generalized theoretical modelling approach for the assessment of economic-capital under asset market liquidity risk constraints

Mazin A.M. Al Janabi

    Research output: Contribution to journalArticlepeer-review

    13 Citations (Scopus)

    Abstract

    This paper proposes a concrete theoretical foundation and a new modelling framework that attempts to tackle the issue of market/liquidity risk and economic-capital estimation at a portfolio level by combining two mutual asset market/liquidity risk models. In essence, this study extends research literature related to the assessment of the asset market/liquidity risk by providing a generalized theoretical modelling underpinning that handle, from the same perspective, market and liquidity risks jointly and integrate both risks into a portfolio setting without a commensurate increase of statistical postulations. As such, we argue that market and liquidity risk components are correlated in most cases and can be integrated into one single market/liquidity framework that consists of two interrelated sub-components. The first component is attributed to the impact of adverse price movements and is modelled based on the concept of liquidity-adjusted value-at-risk framework, while the second component focuses on the risk of variation in transactions costs due to the bid-ask spreads and it attempts to measure the likelihood that it will cost more than expected to liquidate the asset position. As such, the model comprises a new approach to contemplating the impact of time-varying volatility of the bid-ask spread and its upshot on the overall asset market/liquidity risk. The modelling framework can be constructive for financial service industries in emergingeconomies and particularly in reinforcing rational economic-capital allocation in light of the aftermaths of the sub-prime financial crisis.

    Original languageEnglish
    Pages (from-to)2193-2221
    Number of pages29
    JournalService Industries Journal
    Volume31
    Issue number13
    DOIs
    Publication statusPublished - Oct 2011

    Keywords

    • Economic-capital
    • Emerging markets
    • Financial engineering
    • Financial markets
    • Financial risk management
    • Financial service industries
    • Liquidity adjusted value at risk
    • Liquidity risk
    • Portfolio management

    ASJC Scopus subject areas

    • Strategy and Management
    • Management of Technology and Innovation

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