Liquidity-adjusted VaR

What it means

VaR extended to include the cost of closing the position — the bid–ask spread and the market impact of exiting at size.

The exam angle

The gap between VaR and its liquidity-adjusted version widens sharply for concentrated or illiquid books, which is exactly when it matters.

Where it appears in the syllabus

• Risk & Investment ManagementFRM Part II · exam weight 15% · Factor theory, risk budgeting, attribution, hedge funds, illiquid assets.
• Liquidity & Treasury RiskFRM Part II · exam weight 15% · Funding vs market liquidity, LVaR, transfer pricing, IRRBB, LCR and NSFR.
• Market Risk Measurement & ManagementFRM Part II · exam weight 20% · VaR and ES estimation, backtesting, EVT, GARCH, copulas, FRTB.

See it worked through

• Value at Risk: the square-root-of-time ruleScale a one-day VaR to ten days with a worked example, and see where the rule breaks.

There is also a short video: watch it on YouTube.

Related terms

• Marginal VaRThe change in portfolio VaR from a small increase in one position — the position’s contribution to total risk at the…
• Return smoothingUnderstated volatility caused by infrequent or appraisal-based valuations rather than by genuinely stable prices.
• Arbitrage pricing theoryA model deriving expected returns from exposures to multiple systematic factors, assuming no arbitrage rather than a…
• Factor investingBuilding portfolios around systematic return drivers — value, size, momentum, quality, low volatility — rather than…
• Hedge fund replicationReproducing hedge fund returns using liquid instruments and factor exposures, rather than by paying for the funds…
• Multifactor modelA model explaining returns by exposure to several systematic factors rather than to the market alone.