Liquidity Risk

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What is 'Liquidity Risk'

Liquidity risk is the risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. Liquidity risk is typically reflected in unusually wide bid-ask spreads or large price movements (especially to the downside). The rule of thumb is that the smaller the size of the security or its issuer, the larger the liquidity risk.

BREAKING DOWN 'Liquidity Risk'

Although liquidity risk is largely associated with micro-cap and small-cap stocks or securities, it can occasionally affect even the biggest stocks during times of crisis. The aftermath of the 9/11 attacks and the 2007-2008 global credit crisis are two relatively recent examples of times when liquidity risk rose to abnormally high levels. Rising liquidity risk often becomes a self-fulfilling prophecy, since panicky investors try to sell their holdings at any price, causing widening bid-ask spreads and large price declines, which further contribute to market illiquidity and so on.

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RELATED FAQS
  1. What is liquidity risk?

    Learn how to distinguish between the two broad types of financial liquidity risk: funding liquidity risk and market liquidity ... Read Answer >>
  2. How much liquidity is considered too much liquidity?

    Learn about the risks of holding too much cash or investing in assets that are too liquid, and discover how liquidity is ... Read Answer >>
  3. What types of stocks have a large difference between bid and ask prices?

    Find out which factors influence bid-ask spread width. Learn why some stocks have large spreads between bid and ask prices, ... Read Answer >>
  4. How do I use the bid-ask spread to evaluate whether I should buy a particular stock?

    Understand the significance of the bid-ask spread for investors in making a decision on whether or not to purchase a particular ... Read Answer >>
  5. What are some of the risks of holding liquid assets?

    Find out how the holders of liquid assets assume risks associated with opportunity cost and inflation in exchange for solvency ... Read Answer >>
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