A model for the valuation of assets with liquidity risk

Bert-Jan Nauta

Journal of Risk

Abstract: This paper describes a model for the valuation of assets on a bank balance sheet with liquidity risk. The new feature of this model is that it explicitly incorporates the funding term of an asset. The inclusion of the funding term is important, as it determines the expected liquidation loss. By minimizing the sum of the expected liquidation loss and funding costs, the optimal funding term and value of the asset can be determined. This paper applies the model to single cashflows, loans, bonds and derivatives. In addition, the calibration to London Interbank Offered Rate basis spreads is discussed.

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