FRM Part II · FRM Exam Part II · Liquidity Risk
Which statement best describes exogenous versus endogenous liquidity risk in the context of bid-ask spreads?
Exogenous liquidity risk is market-wide and reflected in the quoted spread, beyond any single trader's control. Endogenous liquidity risk comes from the price impact of a trader's own large position or order, which the quoted spread does not capture for big trades.
- AExogenous liquidity depends on the size of the individual trader's position, while endogenous liquidity is common to all market participants
- BExogenous liquidity is common to all market participants and captured by the quoted spread, while endogenous liquidity arises from the price impact of a specific trader's own large positionCorrect
- CBoth are driven only by the trader's position size but differ in time horizon
- DEndogenous liquidity is captured entirely by the quoted bid-ask spread, while exogenous liquidity is unobservable
Explanation
Exogenous liquidity reflects market-wide conditions that the quoted spread represents and is outside any one trader's control. Endogenous liquidity is the extra price concession caused by a trader's own large order. The first option reverses the definitions.
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