How large is liquidity risk in an automated

Department of Economics University of St.. GallenHow large is liquidity risk in an automated auction market?. Pierre Giot, Joachim Grammig August 2002 Discussion paper no... How large is

Department of Economics University of St Gallen

How large is liquidity risk in an automated auction market ?

Pierre Giot, Joachim Grammig August 2002 Discussion paper no 2002-23

Editor: Prof Jörg Baumberger

University of St Gallen Department of Economics Bodanstr 1

CH-9000 St Gallen Phone ++41 71 224 22 41

Email joerg.baumberger@unisg.ch Publisher:

www.fgn.unisg.ch/public/public.htm

How large is liquidity risk in an automated auction market ? 1

Pierre Giot, Joachim Grammig

Schweizerisches Institut für Banken und Finanzen Universität St Gallen

Rosenbergstr 52 CH-9000 St Gallen

Email joachim.grammig@unisg.ch Website www.sbf.unisg.ch

1 Pierre Giot is Professor of Finance at the Department of Business Administration & CEREFI at University of Namur, Rempart de la Vierge, 8, 5000 Namur, Belgium Phone: +32 (0) 81 724887 Email: pierre.giot@fundp.ac.be Both authors are research fellows at CORE, Université Catholique de Louvain, Belgium We are grateful to Deutsche Börse AG for providing access to the limit order data and to Kai-Oliver Maurer and Uwe Schweickert who provided invaluable expertise regarding the Xetra trading system, as well as Rico von Wyss, Michael Genser and participants at the Department of Economics Brown Bag workshop who offered helpful comments We also thank Helena Beltran-Lopez for her cooperation in the preparation of the datasets and Bogdan Manescu for research assistance.

We introduce a new empirical methodology that takes account of liquidity risk in a Risk framework, and quantify liquidity risk premiums for portfolios and individual stocks traded on the automated auction market Xetra which operates at various European

Value-at-exchanges When constructing liquidity risk measures we allow for the potential price impact incurred by the liquidation of a portfolio We study the sensitivity of liquidity risk towards portfolio size and VaR time horizon, and interpret its diurnal variation in the light of market microstructure theory.

Keywords

Liquidity, Value-at-Risk, Microstructure

JEL Classification

G10, G14, G15

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