Going beyond the simple bid–ask spread overlay for a particular value at risk, the author introduces an innovative framework that integrates liquidity risk, funding risk, and market risk. He overlaid a whole distribution of liquidity uncertainty on future market risk scenarios and allowed the liquidity uncertainty to vary from one scenario to another, depending on the liquidation or funding policy implemented. The result is one easy-to-interpret, easy-to-implement formula for the total liquidity-plus-market-risk profit and loss distribution.

Author Information

Attilio Meucci, CFA, is head of portfolio construction at Kepos Capital, New York City.

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