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FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

During the 2007-2009 crisis, many leveraged funds were forced to sell assets as prices fell, which pushed prices down further and triggered more margin calls. This feedback mechanism is best described as:

This is a liquidity spiral: falling prices tighten margins and funding, forcing leveraged investors to sell, which pushes prices lower and tightens funding again. It links market liquidity and funding liquidity in a reinforcing loop that amplifies systemic stress.

  1. AA liquidity spiral linking market liquidity and funding liquidityCorrect
  2. BSurvivorship bias
  3. CBasis risk
  4. DA diversification benefit

Explanation

Falling prices raise margins and haircuts and reduce funding availability, forcing sales that depress prices further. This reinforcing loop between market and funding liquidity is a liquidity spiral. The other terms do not describe this loop.

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