In a recent comment (see "Waltzing through the blogospher," November 28, 2009) Steve Campisi wrote about the need to measure liquidity risk, citing the difficulties that the Yale Endowment fund had. It just so happens that this month's Institutional Investor's cover story deals with the huge drop in assets major colleges have seen in their endowments, effective the fiscal year ending this past June 30. The drops have been quite staggering, with the average loss being roughly 20 percent.
I'm intrigued by the notion of liquidity risk, but I can see huge challenges with it, too. How does one properly assess this risk, especially when the variables that can impact it can be quite significant. It was probably a lot easier selling your Dubai World bonds a few weeks ago than it is today, right? During a flight to quality liquidity dries up. If you don't have to sell an asset that is down, you can perhaps afford to wait around to see if it recovers its value. But, there are times when you must sell, thus you encounter liquidity risk and lower prices. Long-Term Capital Management WAS able to recover the value of just about all of their assets...the problem was they couldn't afford to hang around and had to be bailed out. Perhaps stress testing your portfolio would be one way to determine what your risk is.
More details will help, and we hope to see this topic explored in greater detail.