Liquidity risk management in institutional investment firms : an honors thesis (HONRS 499)
Recent economic turmoil has forced institutional investment firms to place more emphasis on liquidity. Firms such as banks, hedge funds, insurance companies, endowments, and pension funds all face a unique set of liquidity risk factors. There are several methods for measuring liquidity risk available to firms. However, these measures are subject to interpretation errors as well as errors in definition. Institutional investment firms need to understand liquidity risk measures as well as the factors that are involved in determining these measures. Firms can only manage their liquidity risk if they understand the risks that they are subject to and how to measure that risk. Liquidity risk management techniques that are viable for certain firms may not pertain to others. Regulatory requirements as well as firm-specific liquidity profiles are also important factors in determining the appropriate methods of quantifying and managing liquidity risk. This paper analyzes the liquidity risk profile of banks, hedge funds, insurance companies, endowments, and pension funds and offers several liquidity measures that can be utilized by firms. I suggest measures that may be more applicable to certain firms. There is also a discussion of the immunization technique for liquidity risk management. While this technique is not always applicable, it is powerful in managing liquidity risk.