Liquidity Risk with Coherent Risk Measures

Abstract

This paper concerns questions related to the regulation of liquidity risk, and proposes a definition of an acceptable portfolio. Because the concern is with risk management, the paper considers processes under the physical (rather than the martingale) measure. Basically, a portfolio is ‘acceptable’ provided there is a trading strategy (satisfying some limitations on market liquidity) which, at some fixed date in the future, produces a cash‐only position, (possibly) having positive future cash flows, which is required to satisfy a ‘convex risk measure constraint’.

Keywords:

• Coherent risk measures
• liquidity risk
• acceptable portfolio

Acknowledgement

The author thanks David Heath for useful discussions and the referee for helpful comments. This research has been supported by NSERC Discovery grant 504316.