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FRM Part II · FRM Exam Part II · Illiquid Assets

A risk manager wants to measure liquidity-adjusted risk for a portfolio containing thinly traded private loans that can only be sold at a discount in stress. Which approach best captures this?

The best approach is to lengthen the liquidation horizon for illiquid positions to match the realistic time needed to exit and to add stressed price-concession or bid-ask costs. A standard short horizon or excluding the positions would understate the true liquidity-adjusted risk.

  1. AUse a one-day VaR with a standard horizon for all assets
  2. BExtend the liquidation horizon for illiquid positions to reflect time needed to exit, and add a stressed bid-ask or price-concession costCorrect
  3. CReduce volatility estimates since illiquid assets trade rarely
  4. DExclude illiquid positions from risk measurement because they have no market price

Explanation

Liquidity-adjusted risk lengthens the holding period to match realistic exit time and includes transaction or price-impact costs under stress. A one-day horizon ignores exit time, lower volatility reflects smoothing not true risk, and exclusion hides exposure.

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