FRM Part II · FRM Exam Part II · Liquidity Risk
A risk manager compares the constant-spread LVaR approach with an exogenous-spread approach that includes spread volatility. Relative to the constant-spread approach, the exogenous-spread approach is best described as:
The exogenous-spread approach is more conservative. It adds a term for spread volatility, reflecting wider spreads in stressed conditions, on top of the average spread cost used by the constant-spread approach. It still treats spreads as independent of the firm's own trading, so it does not capture endogenous price impact.
- AMore conservative, because it adds a term for the possibility that spreads widen in stressed marketsCorrect
- BLess conservative, because it removes the mean spread from the calculation
- CEquivalent, because spread volatility offsets mean spread in all markets
- DUnrelated to spreads, because it models only the price impact of trade size
Explanation
The constant-spread approach adds only the cost from the average spread. The exogenous-spread approach adds a spread-volatility component, so the cost estimate reflects a worse-than-average spread at the chosen confidence level. It still treats spreads as unaffected by the firm's own trades, and it does not remove the mean spread.
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