Risk Allocation under Liquidity Constraints

Péter Csóka and P. Jean-Jacques Herings

No 1331, CERS-IE WORKING PAPERS from Institute of Economics, Centre for Economic and Regional Studies

Abstract: Risk allocation games are cooperative games that are used to attribute the risk of a financial entity to its divisions. In this paper, we extend the literature on risk allocation games by incorporating liquidity considerations. A liquidity policy specifies state-dependent liquidity requirements that a portfolio should obey. To comply with the liquidity policy, a financial entity may have to liquidate part of its assets, which is costly. The definition of a risk allocation game under liquidity constraints is not straight-forward, since the presence of a liquidity policy leads to externalities. We argue that the standard worst case approach should not be used here and present an alternative definition. We show that the resulting class of transferable utility games coincides with the class of totally balanced games. It follows from our results that also when taking liquidity considerations into account there is always a stable way to allocate risk.

Keywords: Market Microstructure; Coherent Measures of Risk; Market Liquidity; Portfolio Performance Evaluation; Risk Capital Allocation; Totally Balanced Games (search for similar items in EconPapers)
JEL-codes: C71 G10 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2013-09
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Related works:
Journal Article: Risk allocation under liquidity constraints (2014)
Working Paper: Risk Allocation under Liquidity Constraints (2014)
Working Paper: Risk Allocation under Liquidity Constraints (2014)
Working Paper: Risk allocation under liquidity constraints (2013)
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