Finance Junkie
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Postby » Fri Sep 19, 2014 4:36 am

A global macro hedge fund has a large position in natural gas contracts. The fund manager has calculated the 1-
day value at risk (VaR) of the position. However, given the magnitude of the position it is most likely that any
liquidation will take place over three trading days. Which of the following formulas correctly represents the
adjustment needed to arrive at liquidity-adjusted VaR?
A) VaRt × 1.3693.
B) VaRt × 1.2472.
C) VaRt × 0.7817.
D) VaRt × 0.7454.
Your answer: B was correct!
Liquidity-adjusted VaR is a tool used to measure the risk of adverse price impact. Traders will often liquidate
positions over a period of days in order to ensure an orderly liquidation of the position. In this question, we are
informed that T equals 3 days. As a result, we can simplify the above equation to arrive at the appropriate
adjustment needed for the 1-day VaR.
liquidity-adjusted VaR = VaRt × √[(4 × 7) / 18] = VaRt × 1.2472

I did not undersand √[(4 × 7) / 18 part.. Please clarify
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Finance Junkie
Posts: 709
Joined: Wed Apr 09, 2014 6:28 am


Postby edupristine » Thu Sep 25, 2014 8:29 am

If the position is liquidated over a period of T days, then use the below formula

VAR * sqr root of ([(1+T)(1+2T)]/6T)

In the above question, T=3, please put the values in the formula and you will get the answer.

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