Extreme Events in Finance

Chapter 23Two Tales of Liquidity Stress

Jacques Ninet

Senior Research Advisor with La Française Group and Convictions AM. La Française, Paris

Liquidity is well known as one of the three risks inherent to any financial activity, together with market volatility (valuation) and solvency (credit) risk. However, it is not recognized as it should, in our opinion, as the most lethal risk. This misunderstanding has probably much to do with the fact that overall liquidity crisis occurs only under special systemic circumstances whereas market fluctuations are the common rule and credit risk is the essence of banking business. Market prices uncertainty has inspired thousands of academic researches and econometric pricing models in which the tails of return distributions are often discussed, as they are in this book, and professionals have built up hundreds of allocation tools. Debt solvency has for its part been the key issue for banks and rating agencies for more than one century. Comparatively, the channels of liquidity stress in the globalized financial world are not so richly documented. In this chapter, we present two stories of liquidity stress that occurred in the French Money Market Funds (MMF) universe. These stresses, which resulted from extreme events in credit and/or foreign exchange markets, fully demonstrate that the liquidity risk is indeed the worst of the trio, because once it bursts, insufficiently prepared financial companies will inevitably go belly up, unless they ...