Friday, March 20, 2009

Willie Coyote risk and liquidity events


Willie Coyote risk occurs when the bottom falls out of a market usually when there is a shortage of liquidity because of a pullback of credit. 

The number one issue for hedge funds and credit markets will be liquidity risk and the ability to obtain financing to undertake arbitrage trades. Markets will not converge if there is risk of financing over the life of trades. This is one of the reason for why the markets have not cleared for many toxic assets. There is a high probability to that many of these assets will pay-out close to par especially if there are are highly rated but the issue is getting financing for any buy and hold strategy. This is the reason for government financing to unlock credit markets. It can step in during rare liquidity events in order to ensure financing for potential buyers. 

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