I was fortunate enough to receive the Enrichment Award from the Honors Program for this summer. With the award, I will be learning about liquidity risk and how actuarial science can play a role in measuring this risk. The reason that I chose to study liquidity risk is because I was interested in applying for a Research Experience for Undergraduates (REU). After some research, Professor Hong, an actuarial science professor at RMU, and I discovered that Worcester Polytechnic Institute (WPI) runs an REU that incorporates actuarial science. Over the past few years, a reoccurring topic of study has been liquidity risk, and the professor that usually oversees the project is Professor Marcel Blais. I knew that I was not qualified to participate in the research for this summer, however I wanted to take time to learn more about liquidity risk in case I wanted to pursue researching it next summer; the Enrichment Award is allowing me to do that.
Once I had a topic, I needed to figure out what resources I would use to learn about liquidity risk. Professor Hong was a big help and found an article written by two professors including Blais. I knew that I had to read that in order to figure out if pursuing the REU at WPI was a path I wanted to take. However, I needed to gather some base knowledge on the subject before reading Blais’s article. I started learning about liquidity risk by reading An Index-Based Measure of Liquidity by Chacko, Das and Fan. I chose this article because it is current, published in January of 2016, and had a thorough introduction section.
After reading through the first few pages of this article I realized that I needed to brush up on some economic vocabulary related to the exchange market and specifically hedge funds. I did everything from watching Khan Academy videos to reading lecture notes from NYU in order prepare for what I wanted to learn. I am still working on my second read-through of An Index-Based Measure of Liquidity but I have found an article titled Measuring Systemic Liquidity Risk and the Cost of Liquidity Insurance prepared by Tiago Severo. I hope that this article will be the key to bridging the gap between what I know about actuarial science and liquidity risk.
So far, I have learned that the 2007 global financial shock was closely related to a series of liquidity events in the credit markets. Banks, insurance companies, hedge funds and pension funds all realized how sensitive their balance sheets were to liquidity. Academics have increased their interest in studying liquidity risk. The problem that they are facing is that it is very difficult to measure because it is a latent risk factor. It is nearly impossible to isolate liquidity risk for observation. Now that I have a better grasp on what liquidity risk actually is, I can read papers written about different methods of trying to measure liquidity risk. As the summer progresses, I hope to better understand the process and mathematics that goes into developing an approach to measuring this risk.