By Rob Haddad, Head of Product Strategy and Innovation, ICE Data Services
Liquidity risk is ubiquitous. At all times, the inherent risk associated with converting an investment to cash lurks under the surface and we don’t “see” it until we attempt to initiate a transaction – like when trying to sell a house in the northeastern U.S. in December (I was conducting market research, of course).
“…selling a house in the northeast in December would have resulted in far too great of a price impact, thus I deferred the sale until April in order to take advantage of perceived improved liquidity conditions.”
The level of acceptable liquidity risk exposure is also in the eye of the beholder. For example, based on their own facts and circumstances, two people may fundamentally differ in their view of the acceptable haircut off the current price they are willing to absorb to accommodate a liquidation scenario. Timing plays a key role here, too. For instance, selling a house in the northeast in December would have resulted in far too great of a price impact, thus I deferred the sale until April in order to take advantage of perceived improved liquidity conditions. This means more expected demand from the market and a much tighter difference between asking price and ultimate transaction value. And, a better home sale price for me.
Relating this concept to the financial markets, the SEC’s Liquidity Risk Management Program focuses the attention of mutual fund companies on implementing formal liquidity risk management programs for their portfolio investments. This is not an easy exercise. At ICE Data Services, we are working with our mutual fund clients to support their management of aspects of the rule, including generating liquidity classifications for portfolio investments through our ICE Liquidity IndicatorsTM service. It is important for our service to accommodate a variety of perspectives from our clients, so they can incorporate their specific viewpoints and assumptions to measure liquidity based on their facts and circumstances.
Recently, we hosted a webinar where our audience provided their perspective on a number of topics including what constitutes an acceptable level of price impact for liquidation scenarios in the financial markets. The visual below takes into account responses from 37 webinar participants.
Hover over image to view infographic
In percentage terms, what is your acceptable level of haircut from the current value, if you were liquidating a property you absolutely need to sell in four weeks? What about a High Yield Municipal Bond?
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