Risk Professional - December 2009

value, and is affected by the same risk factors. It is therefore not a risk source comparable to market, credit, insurance or WXMZI\QWVIT;ZQ[S;;J]\;I;ZQ[S;MNNMK\;;[MM;.QO]ZM;;*;;JMTW_;;

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Market liquidity risk, which arises when credit markets NZMMbM;L]M;\W;I;TW[[;WN;KWVÅLMVKM;WZ;_QLM[XZMIL;NMIZ;;Q[;LQN- ferent. While a bank is responsible for its own idiosyncratic liquidity risk, the same does not apply to market liquidity risk, _PQKP;INNMK\[;M^MZa;NIK\WZ;;ZMOIZLTM[[; WN ;Q\[;ÅVIVKQIT;[\ZMVO\P;; 4W[[; WN ; KWVÅLMVKM; Q[; UIVQNM[\ML; \PZW]OP; QVKZMI[QVO; KZMLQ\; risk spreads, and it is this phenomenon that reveals the true nature of market liquidity risk. Indeed, market liquidity risk is a special case of credit risk where there is a general distrust of any counterparty partaking in the market.

To summarize, liquidity risk is not an independent risk category. Idiosyncratic liquidity risk is a risk effect, and arises mainly from reputational, or more broadly, operational risk. In particular, it is an analytical output on an equal footing with value, and should be derived in parallel with it. Market liquidity, at least from an analytical perspective, is a special

case of credit risk, and should therefore be managed and measured via credit spreads.

Final Thoughts

Market risk and credit risk analysis can be consistently per- NWZUML;][QVO;I;KITK]TI\QWV;UM\PWLWTWOa;KMV\MZML;WV;I;ÅVIV- cial contract. The same is true for life insurance analysis, and can be extended in a straightforward manner to non-life insurance by adding severity and loss triangles information.

Operational risk is less straightforward than it is usually presented in literature. Managing this risk is primarily done using classical managerial tools, and has little to do with risk analysis.

4QY]QLQ\a;ZQ[S;Q[;\PM;UW[\;LQNÅK]T\;\W;]VLMZ[\IVL;;<PQ[;LQ[KQ- pline covers two distinct types of risk: idiosyncratic (or structural) liquidity risk and market liquidity risk. Idiosyncratic liquidity risk is not a risk factor at all; rather, it is an analytical output similar to value, and since Idiosyncratic liquidity risk and value are affected by the same risk factors, they should be analyzed in parallel. Market liquidity risk, on the other hand, is an indication of widespread distrust toward all counterparties, and thus represents a special case of credit risk.

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