Assessing Performance of Liquidity Adjusted Value-at-Risk Models

Vandana Rao Daka and Sankarshan Basu

International Journal of Financial Research, 2016, vol. 7, issue 5, 87-98

Abstract: In this paper, a portfolio-level Liquidity Adjusted Value at Risk model is formulated by using the adapted approach based on the Cornish-Fisher expansion technique to account for non-normality in liquidity risk. Most models ignore the fact that liquidity costs which measure market liquidity are non-normally distributed and this leads to a severe underestimation of the total risk. The Cornish-Fisher expansion technique, as proposed by prior studies is used for correcting the percentiles of a standard normal distribution for non-normality and is simple to implement in practice. The empirical evidence obtained in this study shows that accounting for non-normality at portfolio level and using the modified approach produces much more accurate results than alternative risk estimation methodologies. The model is tested using emerging markets¡¯ data as research on liquidity that primarily focuses on emerging markets yield particularly powerful tests and useful independent evidence since liquidity premium is an important feature of these data.

Keywords: value at risk; liquidity costs; emerging markets (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:jfr:ijfr11:v:7:y:2016:i:5:p:87-98

DOI: 10.5430/ijfr.v7n5p87

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