Explanation:
The exogenous liquidity risk corresponds to the normal variation of bid/ask spreads across instruments. This type of risk is theoretically easy to integrate into a VaR framework. Exogenous liquidity risk is beyond the control of the trader and is rooted in the characteristics of the markets. The key element in determining exogenous liquidity risk is associated with accurately modeling the behavior of the spread. This risk is not specific to the characteristics of the position and will, therefore, vary across markets.
Choice A is incorrect. The endogenous component of liquidity risk does not correspond to the average transaction costs set by the market for standard transaction sizes. Instead, it refers to the risk that arises from the interaction of market participants and their trading activities, which can affect a firm's ability to execute transactions at favorable prices.
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Q.1535 The amalgamation of VaR models and market liquidity requires a distinction between exogenous and endogenous liquidity. Which of the following descriptions is correct?
A
The endogenous component of liquidity risk corresponds to the average transaction costs set by the market for standard transaction sizes.
B
The exogenous liquidity risk corresponds to the normal variation of bid/ask spreads across instruments.
C
The endogenous risk of collective portfolio adjustments is easier to include in a VaR computation.
D
The exogenous component corresponds to the impact on prices of the liquidation of a position in a relatively tighter market.
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