By Robert Fiedler
Liquidity chance is difficult to appreciate. It has to be damaged down into its parts and drivers with a purpose to deal with and version it effectively. The industry turmoil that all started in mid-2007 re-emphasised the significance of liquidity to the functioning of economic markets and the banking region. ahead of the turmoil, asset markets have been buoyant and investment used to be available at low-priced. The reversal in industry stipulations illustrated how quick liquidity can evaporate and that illiquidity can final for a longer time period. monetary regulators around the globe are urging associations to handle this measurement of economic hazard extra comprehensively. during this accomplished advisor to modelling liquidity probability, Robert Fiedler offers a coherent version which permits the reader to appreciate the parts of illiquidity chance and the way they have interaction and hence enable you construct a quantitative version to show, degree and restrict possibility. Liquidity Modelling is needed studying for monetary industry practitioners who're facing liquidity chance and who are looking to know it
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Extra resources for Liquidity Modelling
V(AM ), the values of the assets, and v(L1 ), . . , v(LN ), the values of the liabilities. Let vA = v(A1 ) + · · · + v(AM ) and vL = v(L1 ) + · · · + v(LN ) denote their sums. The number c := vA − vL is called equity capital and indicates insolvency: a bank is called insolvent if the value vA of its assets is less than the value vL of its liabilities (vA < vL ), which is equivalent to vA − vL = c < 0. VALUE, RISK AND CAPITAL The calculation of capital is not straightforward. The above determination of capital (c = vA − vL ) is formally correct but ignores the practical problem of determining the individual value of each asset or liability.
These contracts may include payment obligations between the counterparties, which are settled by transferring assets (normally central bank funds) at a given date to a specified nostro account the counterparty holds with another bank. As long as a bank fulfils all of its contractual payment obligations that fall due, it is liquid. If at some point in time (now or in the future) the bank does not execute one (or more) of these payment obligations, the bank has defaulted on the payment and thus becomes illiquid.
At that point in time it does not make any sense to connect the deposited capital to specific cash outflows or the corresponding assets or cost. We go back to the idea of capital as accumulator of profits (or, respectively, losses) and describe for our purposes capital in a way which is derived from accounting (which goes back to 15 ✐ ✐ ✐ ✐ ✐ ✐ “fiedler_reprint” — 2012/8/10 — 13:44 — page 16 — #30 ✐ ✐ LIQUIDITY MODELLING such authorities of classical economics as Max Weber and Werner Sombart): The very concept of capital is derived from this way of looking at things; one can say that capital, as a category, did not exist before double-entry bookkeeping.