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

In a liquidation model, a trader with high risk aversion is compared with one with low risk aversion, both selling the same position with the same market impact parameters. Which statement about their optimal schedules is correct?

The more risk-averse trader sells faster. Greater aversion to the variance of final proceeds makes holding unsold inventory costly, so the schedule is front-loaded and accepts higher market impact, whereas a less risk-averse trader spreads sales out more evenly to reduce impact.

  1. AThe more risk-averse trader liquidates faster, accepting higher impact costs to reduce price riskCorrect
  2. BThe more risk-averse trader liquidates more slowly to minimize impact costs
  3. CBoth traders choose identical schedules because impact is independent of risk aversion
  4. DThe less risk-averse trader liquidates faster because volatility is irrelevant to him

Explanation

Higher risk aversion places more weight on variance of proceeds, so the optimal schedule is front-loaded, accepting more impact. A risk-neutral trader would spread trades evenly to minimize impact. The slower-liquidation claim reverses this.

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