Liquidity Risk

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DEFINITION of 'Liquidity Risk'

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. How is liquidity risk captured by the cash conversion cycle (CCC)?

    Liquidity risk is captured by the cash conversion cycle (CCC) through the use of days inventory outstanding, days sales outstanding ... Read Full Answer >>
  2. What are some safe fixed-income investments?

    For the majority of younger investors, taking on risk within a portfolio in return for higher returns is the norm. Because ... Read Full Answer >>
  3. How does the risk profile of private equity investments compare to those of other ...

    High-net-worth investors have embraced the strategy of placing a portion of their equity positions in alternative assets ... Read Full Answer >>
  4. What are the risks associated with investing in the banking sector?

    Risks associated with investing in the banking sector include operational risk, market risk, cybersecurity, funding risks, ... Read Full Answer >>
  5. Why are the bid prices of T-bills higher than the ask prices? Aren't bids supposed ...

    Yes, you are correct that the ask price of a security should typically be higher than the bid price. This is because people ... Read Full Answer >>
  6. What number of shares determines adequate liquidity for a stock?

    Liquidity refers to how easy it is to buy and sell shares without seeing a change in price. If, for example, you bought ... Read Full Answer >>
  7. What are the components of the risk premium for investments?

    The risk premium is the excess return above the risk-free rate that investors require as compensation for the higher uncertainty ... Read Full Answer >>

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