Liquidity Risk
AdvancedLiquidity risk is the risk that an investor or institution cannot buy or sell an asset quickly enough, or at a fair price, or cannot obtain enough cash to meet its obligations when they fall due.
Liquidity risk has two main forms. Market liquidity risk is the risk that an asset cannot be sold quickly without accepting a much lower price, because there are few buyers. Funding liquidity risk is the risk that a business or financial institution cannot raise the cash it needs to pay its bills, even if it is solvent.
For example, an investor holding shares in a small company that trades infrequently may find that selling a large holding pushes the price down sharply. A bank that has lent out deposits for long periods may struggle if many depositors withdraw at once.
Liquidity risk can rise suddenly during market stress, when buyers disappear and many investors try to sell at the same time. Assets that seemed easy to sell in normal times may become hard to trade.
Investors manage liquidity risk by holding some easily sold assets, avoiding funding long-term assets with short-term borrowing and matching investments to when they will need money. Banks are subject to regulatory liquidity requirements for the same reason.
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