It is debatable whether the hedge was effective from a market risk standpoint, but it was the liquidity crisis caused by staggering margin calls on the futures that forced Metallgesellschaft to unwind the positions.
If an organization's cash flows are largely contingent, liquidity risk may be assessed using some form of scenario analysis.
A general approach using scenario analysis might entail the following high-level steps: Because balance sheets differ so significantly from one organization to the next, there is little standardization in how such analyses are implemented.
A company with a negative liquidity gap should focus on their cash balances and possible unexpected changes in their values.
As a static measure of liquidity risk, it gives no indication of how the gap would change with an increase in the firm's marginal funding cost.
This spread is composed of operational, administrative, and processing costs as well as the compensation required for the possibility of trading with a more informed trader.
Knight and Satchell mention a flow trader needs to consider the effect of executing a large order on the market and to adjust the bid–ask to spread accordingly.
Hachmeister identifies the fourth dimension of liquidity as the speed with which prices return to former levels after a large transaction.
"[9] Alan Greenspan (1999) discusses management of foreign exchange reserves and suggested a measure called liquidity at risk.
A country's liquidity position under a range of possible outcomes for relevant financial variables (exchange rates, commodity prices, credit spreads, etc.)
In addition, countries could be expected to hold sufficient liquid reserves to ensure that they could avoid new borrowing for one year with a certain ex ante probability, such as 95 percent of the time.
[10] The FDIC discuss liquidity risk management and write "Contingency funding plans should incorporate events that could rapidly affect an institution’s liquidity, including a sudden inability to securitize assets, tightening of collateral requirements or other restrictive terms associated with secured borrowings, or the loss of a large depositor or counterparty.
The American Academy of Actuaries wrote "While a company is in good financial shape, it may wish to establish durable, ever green (i.e., always available) liquidity lines of credit.
Regression analysis on the 3 week return on natural gas future contracts from August 31, 2006 to September 21, 2006 against the excess open interest suggested that contracts whose open interest was much higher on August 31, 2006 than the historical normalized value, experienced larger negative returns.
The firm suffered from liquidity issues despite being solvent at the time, because maturing loans and deposits could not be renewed in the short-term money markets.
[16] In response, the FSA now places greater supervisory focus on liquidity risk especially with regard to "high-impact retail firms".
[17] Long-Term Capital Management (LTCM) was bailed out by a consortium of 14 banks in 1998 after being caught in a cash-flow crisis when economic shocks resulted in excessive mark-to-market losses and margin calls.
Indeed, they estimated that in times of severe stress, cuts on AAA-rated commercial mortgages would increase from 2% to 10%, and similarly for other securities.
In response to this, LTCM had negotiated long-term financing with margins fixed for several weeks on many of their collateralized loans.