FRM Part II · FRM Exam Part II · Liquidity Risk
A bank's market risk team compares standard 99% VaR with LVaR for its portfolio during a market stress episode in which bid-ask spreads widen sharply and trading volumes fall. Which outcome is most likely?
The gap between LVaR and VaR widens. LVaR adds a liquidity cost based on bid-ask spreads to ordinary VaR, so when spreads widen and volumes fall in stress, the add-on rises and LVaR moves further above standard VaR.
- ALVaR falls relative to VaR because volatility declines when volumes fall
- BLVaR and VaR remain equal because liquidity cost is not a market risk
- CThe gap between LVaR and VaR widens because the liquidity cost component increasesCorrect
- DLVaR falls because wider spreads increase the mid-price
Explanation
LVaR equals VaR plus a liquidity cost that rises with spreads. Wider spreads and lower volumes raise the add-on, so the gap grows. Spreads do not raise the mid-price, and liquidity cost is part of LVaR by construction.
Did you get it right without looking?
One question tells you little. A timed set on Liquidity Risk shows your real accuracy, how long you take and where you lose marks.
More Liquidity Risk questions
- A fund must liquidate USD 80 million of a bond. Assume the mid-price is constant and the half-spread is 0.15% for the first USD 20 million, …
- Under the Basel III LCR, a bank has USD 500 million of stable retail deposits with a 5% run-off rate and USD 300 million of unsecured wholes…
- Which statement best describes exogenous versus endogenous liquidity risk in the context of bid-ask spreads?
- Under the Basel III LCR framework, which treatment of a retail deposit is most appropriate?
- A bank's treasurer is designing a liquidity stress test. Which scenario design is most consistent with sound practice for assessing the bank…
- A bank's treasury team is reviewing the Basel III Liquidity Coverage Ratio (LCR). Which statement best describes what the LCR is designed to…