By Christian Schmaltz

Internal liquidity types for banks have won massive value on the grounds that German regulators have determined to simply accept them for regulatory reporting. Christian Schmaltz identifies product funds flows, investment unfold, investment means, haircuts, and momentary rates of interest as key liquidity variables. Then, he assumes particular stochastic procedures for the major variables resulting in a specific liquidity version. The modelling concentration lies at the product money circulation that's defined through a jump-diffusion method. eventually, the writer applies the version to the allocation, inner pricing, and optimization of liquidity.

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Extra info for A Quantitative Liquidity Model for Banks

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Haircuts can be reconciled with bid-ask spreads that are often used as empirical proxies to measure market liquidity in a trading context. 3) constitutes one part of the bid-ask spread, namely the difference between present and liquidation value (ask quote). Put into the bid-ask context, it is the ask-haircut. The second bid-ask component is the difference between purchase value (bid quote) and present value. We denoted this difference HCBid . Thus, the bid-ask spread is the sum of the haircut that the selling and the buying side have to bear.

2. 3. 4. Cash Flows Funding Capacity Funding Spread Haircut The key variables are the variables that a liquidity model has to incorporate. The next section derives the key variables for the Liquidity Option Strategy. 2 Liquidity Option Strategy The second liquidity strategy that generates a return as compensation for liquidity risk is the provision of liquidity options. 11 shows a balance sheet that is examplary for a pure liquidity option strategy: a bank pools customer deposits and invests them in liquid 5Y-bonds and illiquid 5Y-loans.

We choose saving deposits as our example for liquidity options. As P&L-options, we use an American call option on a stock. The liquidity impact of an option is the payoff. The P&L-impact of an 7 The literature does not provide a common term for these products. Deposits are sometimes referred to as non-maturing assets. 30 3 Liquidity Framework option is its price. Prior to maturity, payoff and price differ. For P&L-options, it holds: Price = Payoff + Time Value ≥ Payoff As the time value is positive, the option price is greater or equal to the payoff.

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