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FRM Part II · FRM Exam Part II · Liquidity Risk Management

During a market stress episode, many leveraged funds sell the same asset as prices fall, triggering margin calls that force further selling. Which concept does this describe?

This is endogenous liquidity risk. Forced selling by leveraged funds, driven by margin calls on similar positions, moves prices further against holders and creates a feedback loop. Exogenous liquidity, by contrast, reflects market-wide conditions that an individual trader's actions do not affect.

  1. AEndogenous liquidity risk, where actions of market participants amplify price movesCorrect
  2. BExogenous liquidity risk, arising from a market-wide spread widening independent of any participant
  3. CSettlement risk from delayed delivery
  4. DBasis risk between hedge and exposure

Explanation

Endogenous liquidity depends on the actions of market participants, such as crowded positions and forced sales feeding back into prices. Exogenous liquidity is the market-wide component outside any one trader's control, such as the typical spread.

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