Title: The impact of asset price bubbles on liquidity risk measures from a financial institutions perspective

Authors: Michael Jacobs Jr.

Addresses: Accenture Consulting, Finance and Risk Services Advisory/Models, Methodologies & Analytics, 1345 Avenue of the Americas, New York, N.Y., 10105, USA

Abstract: This study presents an analysis of the impact of asset price bubbles on a liquidity risk measure, the liquidity risk option premium ('LROP'). We present a styled model of asset price bubbles in continuous time, and perform a simulation experiment of a stochastic differential equation ('SDE') system for the asset value through a constant elasticity of variance ('CEV') process. Comparing bubble to non-bubble economies, it is shown that asset price bubbles may cause an firm's traditional risk measures, such as value-at-risk ('VaR') to decline, due to an increase in the right skewness of the value distribution, which results in the LROP to decline and therefore an underpricing of liquidity risk.

Keywords: financial crisis; liquidity risks; model risks; asset price bubbles; value-at-risk; VAR model; stochastic differential equations; SDE; constant elasticity of variance; CEV; risk measures; financial institutions; simulation; skewness; underpricing.

DOI: 10.1504/IJBD.2016.077192

International Journal of Bonds and Derivatives, 2016 Vol.2 No.2, pp.152 - 182

Received: 24 Dec 2015
Accepted: 02 Jan 2016
Published online: 22 Jun 2016 *

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