Chapter 6

Setting the scene

A health warning: liquidity risk

The “keep-it-simple” strategies described in previous chapters should be liquid as well as simple. Almost always, when investment strategy gets more complicated it starts to embrace more liquidity risk. Liquidity is a dimension of risk which is not captured by the off-the-shelf risk models that are routinely used in managing investments. This is because it is difficult to model, not because it does not matter. Dan Borge, a former chief risk manager at Bankers Trust, describes illiquidity as “the most dangerous and least understood financial risk”.

One of the lessons to emerge from the credit crunch of 2007–09 is that investors need a policy on liquidity management. This became evident ...

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