Liquidity Mismatch Measurement

Markus Brunnermeier, Arvind Krishnamurthy, Gary Gorton

This chapter is a preliminary draft unless otherwise noted. It may not have been subjected to the formal review process of the NBER. This page will be updated as the chapter is revised.

Chapter in forthcoming NBER book Risk Topography: Systemic Risk and Macro Modeling, Markus K. Brunnermeier and Arvind Krishnamurthy, editors
Conference held April 28, 2011
Forthcoming from University of Chicago Press

Policymakers and academics recognize that liquidity is central in the dynamics of a financial crisis, and that measurement of liquidity is critical in evaluating and regulating systemic risk. Systemic risk depends primarily on the endogenous response of market participants to extreme events. The liquidity measure is a key response indicator and aggregate liquidity measures are important to detect a build-up of systemic risk in the background during a run-up phase. The purpose of this chapter is to examine the measurement of liquidity in light of the academic research on liquidity. What is the practical and measured counterpart of the theoretical concept of liquidity suggested by models? If one is interested in a liquidity measure that is informative about systemic risk, what measure does the academic research suggest? We discuss a liquidity (risk) measure that is computed conditional on stress scenarios. For each stress scenario and for each asset and liability a cash equivalent dollar value is assigned. The dollar values are aggregated to form a liquidity mismatch index at the level of a firm. The chapter discusses how this metric can be used to gauge systemic risk.

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This paper was revised on May 23, 2013

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