Introduction to 'Liquidity Modelling'

Robert Fiedler

Liquidity risk is hard to understand. It needs to be broken down into its components and drivers in order to manage and model it successfully.

It is important to discern the specific risk of a bank to not be able to execute contractually agreed payments from the general concept of liquidity risk, which also comprises the liquidity of financial products, markets, exchanges, etc.

This book is about the risk of banks losing their ability to stay liquid, or to become illiquid, which we will call illiquidity risk. The term “liquidity risk” describes a status which can be understood straightforwardly (“liquid”) and is then endangered (“risk”); the latter does not require an explicit definition of the perils (subsiding funding base, declining saleability of assets, default of loans, etc, which would be necessary if we were to talk about liquidity risk instead of illiquidity risk).

Illiquidity risk: a risk type of its own?

Many financial professionals regard illiquidity risk not as a risk in itself but only as a “consequential risk” which comes into play after traditional risks have materialised in a loss: if this loss is too big (and becomes public), potential depositors start