One-factor model of liquidity risk

Osadchiy, Maksim (2022): One-factor model of liquidity risk.

Abstract

Credit and liquidity risks at the bank level depend on idiosyncratic and systematic (market) risks at the firm level. Portfolio effect transforms idiosyncratic risk into expected factor and leaves only systematic risk. Dependence only on market risk allows evaluating credit and liquidity risk using one-factor models. Since market risk is common to both credit risk and liquidity risk, it is useful to evaluate their joint distribution in a closed form. The one-factor Vasicek model was designed to evaluate credit risk – the probability distribution of the portfolio loss. The one-factor model proposed in the paper is designed to evaluate liquidity risk. Combination of credit risk and liquidity risk models is used to evaluate the joint distribution of credit and liquidity risks.

• Item Type: MPRA Paper
• Language: English
• Keywords: liquidity risk; credit risk; Vasicek model; barrier option; IRB
• Subjects: G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy ; Liquidation

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