A constraint-based notion of illiquidity
Abstract
This article introduces a new mathematical concept of illiquidity that goes hand in hand with credit risk. The concept is not volume- but constraint-based, i.e., certain assets cannot be shorted and are ineligible as num\'eraire. If those assets are still chosen as num\'eraire, we arrive at a two-price economy. We utilise Jarrow & Turnbull's foreign exchange analogy that interprets defaultable zero-coupon bonds as a conversion of non-defaultable foreign counterparts. In the language of structured derivatives, the impact of credit risk is disabled through quanto-ing. In a similar fashion, we look at bond prices as if perfect liquidity was given. This corresponds to asset pricing with respect to an ineligible num\'eraire and necessitates F\"ollmer measures.
Cite
@article{arxiv.2004.12394,
title = {A constraint-based notion of illiquidity},
author = {Thomas Krabichler and Josef Teichmann},
journal= {arXiv preprint arXiv:2004.12394},
year = {2020}
}