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

Which of the following is the best example of an exogenous liquidity cost, as opposed to an endogenous one, for a large asset manager?

A market-wide widening of bid-ask spreads is exogenous liquidity cost. It affects all participants regardless of their own trades. The other options describe endogenous costs, which arise from the manager's own large order size and its price impact.

  1. AThe price decline caused by the manager's own large sale of a thinly traded bond
  2. BA market-wide widening of bid-ask spreads across all corporate bonds during a crisisCorrect
  3. CThe extra discount obtained because the manager's order size is a large share of daily volume
  4. DThe slippage from the manager's own block order moving the market

Explanation

Exogenous liquidity is the market-wide component common to all participants, such as spread widening, independent of one trader's position. Endogenous liquidity arises from the size of a particular position or the trader's own actions, which describes the other options.

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