A Stress Testing Framework for Liquidity Risk

One of the most important lessons learned from the recent financial crisis is that liquidity risk is fundamentally different from other forms of risk such as market risk and credit risk. Liquidity risk, viewed earlier as a second order risk, is now considered a major risk class. The crisis showed us how quickly a risk which starts as a market or credit risk transforms into a liquidity event and how rapidly it develops into a systemic issue. The drying out of liquidity from the market results in the collapse of traditionally strong institutions.