Correct Answer: B

Liquidity-adjusted VaR (LVaR) integrates traditional VaR with an estimate of the cost of liquidating a position (liquidity cost).

• The constant spread approach assumes the bid-ask spread is deterministic and constant. It simply adds half of this constant spread (multiplied by the position size) to the standard VaR.
• The exogenous spread approach treats the bid-ask spread as a random, normally distributed variable. It factors in both the mean of the spread and its volatility at a specific confidence interval, generally yielding a wider (higher) spread estimate to account for extreme market conditions.

Because incorporating spread volatility increases the estimated liquidity cost, the exogenous approach generally yields a higher LVaR compared to the constant spread approach. If Manchester's LVaR is lower than London's on identical holdings, Manchester is most likely ignoring the spread's volatility and using the simpler constant spread approach.