#### emilioalzamora1

##### Well-Known Member

Hi David,

I stumbled over the following two (confusingly) different calculations for the cost of liquidity (

Bangia (1999)proposes the formula:

CoL = V *{ (mu + deviate*sigma)/2 } where

However, looking at your spreadsheet where you simulate Dowd's LVaR it says the following for the CoL:

1.

the CoL is simply 1/2 times the mean spread.

and would therefore yield a completely different CoL compared to the Bangia equation.

2.

This is more similar to the Bangia equation, but with the little difference of replacing the normal deviate with 'k'

CoL = V* { (mu + k*sigma)/2 }

For the exam, is it enough to know the difference between the two equation's for LVaR given in Jorion (attached): 1. simple LVaR where we add 1/2 of the spread 2. worst-case LVaR with the extended formula?

Any input and discussion is highly appreciated!

Thank you!

I stumbled over the following two (confusingly) different calculations for the cost of liquidity (

**CoL**): comparing the BIS equation (original paper: BCBS_wp19) on page 14 (http://www.bis.org/publ/bcbs_wp19.pdf) for exogenous liquidity and the formula used by K. Dowd (and in your spreadsheet with two different spread calculations):Bangia (1999)proposes the formula:

CoL = V *{ (mu + deviate*sigma)/2 } where

__mu__= (ask-bid)/mid priceHowever, looking at your spreadsheet where you simulate Dowd's LVaR it says the following for the CoL:

1.

**Constant spread:**the CoL is simply 1/2 times the mean spread.

**Referring to the Bangia formula, this would mean: 1/2 * mu**and would therefore yield a completely different CoL compared to the Bangia equation.

2.

__Random spread:__This is more similar to the Bangia equation, but with the little difference of replacing the normal deviate with 'k'

CoL = V* { (mu + k*sigma)/2 }

**where k equals a random number**(3 in your case)

Why is the normal deviate in Dowd's LVaR (exogenous random spread) replaced with a random number (k)?

Why is the normal deviate in Dowd's LVaR (exogenous random spread) replaced with a random number (k)?

For the exam, is it enough to know the difference between the two equation's for LVaR given in Jorion (attached): 1. simple LVaR where we add 1/2 of the spread 2. worst-case LVaR with the extended formula?

Any input and discussion is highly appreciated!

Thank you!