What is a liquidity horizon and how does FRTB assign them?

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AcadiFi · Accepted Answer

Liquidity horizon (LH) is the regulatory estimate of how many days are required to exit or hedge a risk factor without materially moving the market. Under Basel's FRTB, expected shortfall replaces VaR, and risk factors are mapped to five horizons: 10, 20, 40, 60, and 120 days, depending on asset class and liquidity category.

Typical mapping (Basel Committee tables):
- Interest rate (G10 specified currencies): 10 days
- Credit spread investment grade: 20-60 days
- Credit spread non-IG or unlisted: 120 days
- Equity large-cap: 10 days; small-cap: 20 days; vol small-cap: 60 days
- FX major pairs: 10 days; exotic FX: 40 days
- Commodity energy: 20 days; precious metals: 20 days; other commodities: 60 days

The LH scales ES using the square-root-of-time rule with a floor. ES is computed on a base 10-day horizon and then scaled: ES_liquidity = √[ES_base² + Σ (ES_j·√((LH_j - LH_{j-1})/T))²], producing a blended shortfall that penalizes long-LH factors.

Example: Frelvare Bank's macro book has interest rate risk (LH=10), IG credit (LH=40), and commodity agriculture (LH=60). Each bucket contributes an ES term scaled by incremental time. A 10-day ES of $12M on IG credit becomes $12M·√(40/10) = $24M at the 40-day horizon.

Regulators designed longer horizons to capture the reality that illiquid positions cannot be unwound quickly in stress. FRM candidates should know LH influences capital materially — a reclassification from 20-day to 60-day can triple the capital charge.

What is a liquidity horizon and how does FRTB assign them?

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