Abstract
Value-at-risk (VaR) is a common tool applied by market makers to monitor the risk of any trading position. The conventional VaR model assumes a frictionless market, which is seldom the case. The 2008 financial market crisis exposed the inadequacies of VaR limits, which do not factor in liquidity risk. Various liquidity adjusted VaR models exist in an attempt to correct this anomaly. Our study presents a new VaR model that incorporates intraday price movements on high-low spreads and adjusts for a trade impact measure a novel sensitivity measure of price New symbol chosen to denote movements due to trading volumes. The new VaR model returns violations that are independent and identically distributed for 94% of the trading counters backtested over a one-year period of trading on the Johannesburg Stock Exchange using Kupiec’s test of unconditional coverage. The Christoffersen test of independence returns 96% of violations that are neither autocorrelated nor clustered, while the Christoffersen joint test of conditional coverage shows that the average number of violations is correct 93% of the time at 99% significance levels. The new model is valid and robust for the standard VaR backtests conducted.
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