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13 September 2013

Portfolio liquidity risk measures based on our market impact model

liquidity risk measures based on our market impact model In this note, we look at historical
liquidity risk measures based on our market impact model In this note, we look at historical
liquidity risk measures based on our market impact model In this note, we look at historical

In this note, we look at historical liquidity trends. We show that long-term turnover evolution is driven mostly by price levels. We analyse volumes and demonstrate that seasonality explains only part of the variations observed. We examine bid-ask spreads across European small, mid and large caps and highlight the strong link between bid-ask spreads and market volatility.

We then present our market impact model and show how it can be used in practice to estimate expected trading costs. We illustrate the main properties of market impact models. Our model gives practical results applicable within normal trading conditions.

Based on our market impact model, we have built three liquidity risk measures on “trading duration”, “liquidation market impact” and “liquidation market risk”. We illustrate these three measures with small caps portfolios. Lastly, we show how these measures can help risk managers meet the future ESMA requirements for liquidity risk reporting.

IMPORTANT. Please refer to the last page of this report for “Important disclosures” and analyst(s) certifications

Authors

Paul Besson

Head of Quantitative Research pbesson@keplercheuvreux.com +33 1 70 81 57 34

Stéphane Galzin

Quant Research Analyst sgalzin@keplercheuvreux.com +33 1 70 81 57 33

Stéphanie Pelin

Quant Research Analyst spelin@keplercheuvreux.com +33 1 70 81 57 32

Matthieu Lasnier

Quant Research Analyst mlasnier@keplercheuvreux.com +33 1 70 81 57 31

keplercheuvreux.com+33 1 70 81 57 32 Matthieu Lasnier Quant Research Analyst mlasnier@keplercheuvreux.com +33 1 70 81

Quant Research

Contents

Quant Research Contents Introduction 3 Liquidity and its two components 4 Volumes and turnover: fundamental

Introduction

3

Liquidity and its two components

4

Volumes and turnover: fundamental characteristics

4

Bid-ask spreads vary in line with market volatility

7

Market impact overview: theory & practice

9

Market impact models share common properties

9

Practical use and model validity

11

Measuring liquidity risk on a portfolio

12

Portfolio liquidity measures for different market contexts

12

Practical applications for future ESMA regulatory framework

15

Legal and disclosure information

17

Quant Research

Introduction

Before 2008, liquidity issues were often considered to be secondary in asset management.

Since then, liquidity risk has become a key element for risk managers. Today new standards

are emerging and regulators are specifying new obligations.

Liquidity risk has always been a key question for execution and market microstructure

academics. Liquidity risk measures are rooted in market impact models that estimate the

cost of liquidity. These models are extensively used for optimal execution and trading

algorithms.

In this note we show how key quantitative tools, initially developed for execution, can be

applied to liquidity risk analysis for portfolio managers. We first present the main

characteristics of liquidity: volumes and bid-ask spreads. We highlight the general

properties of market impact models. We then present three key measures of liquidity risk.

We conclude by discussing ESMA’s new regulatory requirements.

by discussing ESMA’s new regulatory requirements. Liquidity risk has become a key issue for risk managers

Liquidity risk has

become a key issue for risk managers since

2008

We propose three portfolio liquidity measures based on our market impact model

Quant Research

Liquidity and its two components

The liquidity risk of a portfolio can be defined as the costs incurred from the sale of part of its assets in a given market environment. A portfolio’s liquidity measures depend on its holdings but also on current market liquidity conditions. In this section, we analyse market liquidity characteristics.

Market liquidity has two main components: volumes and bid-ask spreads. They both characterise the capacity of the market to execute a transaction without generating too large a market impact.

Volumes and turnover: fundamental characteristics

Long-term view on European stocks since 2007

The most well-known liquidity measure is market turnover (in cash), but this measure is

greatly influenced by price levels. For this reason volumes (in numbers of shares) are used

to measure trading activity independently of price effects.

Compared with the pre-crisis year of 2007, subsequent years experienced a drop in

turnover, as we can see in Chart 1 (dark blue bars). This drop was mainly driven by prices, as

shown by the Stoxx 600 Index (orange line). Volumes expressed in numbers of shares were

much less volatile. The best example of this situation is the year 2009, when turnover

declined -41% while volumes rose +9% compared with 2007 levels.

The year 2013 to date shows a +9% rise in turnover compared with 2012, accompanied

with a -5% drop in volumes in number of shares. The rise in turnover was mostly driven by

European marketsrecent performances.

Chart 1: Yearly median turnover and volume since 2007*

140

120

100

80

60

40

Turnover 125 Volume DJ STOXX 600 110 109 109 101 96 91 80 79 74
Turnover
125
Volume
DJ STOXX 600
110
109
109
101
96
91
80
79
74
73
59
2007*
2008
2009
2010
2011
2012
2013*

Source: Kepler Cheuvreux data from mid-2007* to August 2013* on Stoxx 600 Europe constituents, equal l weighted measure

on Stoxx 600 Europe constituents, equal l weighted measure Turnover is greatly influenced by price. For

Turnover is greatly

influenced by price. For this reason volume is used to measure

trading activity independently of price

effects

Quant Research

Quant Research Dec-2012 Volume dynamics across large, mid and small caps vary accordingly From 2007 to

Dec-2012

Volume dynamics across large, mid and small caps vary accordingly

From 2007 to 2013, the components of the Stoxx Small Cap Index have had a daily median turnover of EUR5m, compared with EUR16m and EUR78m for mid and large caps, as shown in Chart 2. Volumes evolve in similar ways across market capitalisations, as we can see below. We note large traded volumes on large caps in 2009 (orange line) and strong traded volumes on small caps since 2012 (dark blue line).

Chart 2: Monthly volumes across capitalisations

90 240 Jun-2012 78 Dec-2011 80 220 Jun-2011 70 200 Dec-2010 Jun-2010 60 180 Dec-2009
90
240
Jun-2012
78
Dec-2011
80
220
Jun-2011
70
200
Dec-2010
Jun-2010
60
180
Dec-2009
50
160
Jun-2009
Dec-2008
40
140
Jun-2008
30
120
Dec-2007
16
Jun-2007
20
100
Jan-2007
5
10
80
0
60
Small Mid Large
Median daily turnover (mEUR, 2007-2013*)
Median daily volume
(nb shares, base 100 in 2007*)
Median daily volume (nb shares, base 100 in 2007*) Dec-2013 Jun-2013 Small Mid Large Beyond their
Dec-2013 Jun-2013
Dec-2013
Jun-2013
volume (nb shares, base 100 in 2007*) Dec-2013 Jun-2013 Small Mid Large Beyond their seasonal profile,
Small Mid Large
Small Mid Large

Small

Mid

Large

Beyond their seasonal profile, volumes remain highly volatile

Volume seasonality is a very well-documented phenomenon. Chart 3 below shows the weekly median volume pattern. The dark blue line shows the two typical characteristics of volumes: a large drop usually occurs in the last two weeks of December (-46%, and 66%), and another usually comes in the second week of August (-18%), compared with median yearly levels.

Source: Kepler Cheuvreux data from mid-2007 to August 2013* on Stoxx 600 Europe constituents

Quant Research

Chart 3: Volume seasonality on a weekly basis

220 200 Second week of August (-18%) 180 160 140 120 100 80 60 40
220
200
Second week of August (-18%)
180
160
140
120
100
80
60
40
December’s last two
10% and 90% percentiles
20
weeks (-46 and -66%)
Median
0
Weekly volume / annual weekly volume

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Source: Kepler Cheuvreux data from mid-2007 to August 2013 on Stoxx 600 Europe constituents.

In addition to median patterns, the light blue lines in Chart 3 above show the 10% and 90%

percentiles of weekly volumes. We can clearly see the large variations that occur for a

given week across different years. This shows that the variations in volumes are only partly

explained by yearly seasonality.

Chart 4: Daily volume distribution

150 100 10% percentile: -24% 50 0 0 50 100 150 200 250 300 Number
150
100
10% percentile: -24%
50
0
0
50
100
150
200
250
300
Number of observations

Volume / yearly volume (%)

Source: Kepler Cheuvreux data from mid-2007 to August 2013 on Stoxx 600 Europe constituents

Another way to measure the variability of volumes is to observe the past volume

distribution. We can see in the histogram (Chart 4 above) that in the 10% worst cases, daily

volumes were 24% below their yearly median.

cases, daily volumes were 24% below their yearly median. Despite predictable seasonality, volumes remain highly

Despite predictable

seasonality, volumes

remain highly volatile

To reflect this

volatility, it is essential

to take confidence

intervals into account

We promote the use of VaR metrics when estimating liquidity risk

Quant Research

Quant Research The high variability of volumes should be taken into account in order to compute
The high variability of volumes should be taken into account in order to compute liquidity
The high variability of volumes should be taken into account in order to compute liquidity
risk measures. Long-term average volumes give only a snapshot of market reality. We
recommend considering the 10% lowest volume situations that can be experienced in
practice to account for adverse liquidity situations. That is why we promote the use of VaR
estimates for liquidity risk measures.
Bid-ask spreads vary in line with market volatility
The second main market liquidity characteristic is the bid-ask spread. It reflects the
elementary cost of a transaction. Therefore it is important to determine the drivers of bid-
ask spreads to better understand liquidity risk.
Larger caps often associated with tighter bid-ask spreads
Bid-ask spreads vary with market capitalisation and turnover. In Chart 5, it may be noted
however that bid-ask spreads for small, mid and large caps evolve in a similar manner. In
fact, we see that small cap bid-ask spreads are on average 4bps wider than mid cap bid-ask
spreads, which in turn are 2.5bps larger than large cap bid-ask spreads.
The relationship between free-float adjusted market capitalisation and bid-ask spreads is
described in Chart 6. This shows that on average stocks whose rankings in the Stoxx 600
are larger (i.e. smaller capitalisations) will on average have a higher bid-ask spread (+1.4bps
every 100 rank). This property results from competition between market makers, which is
much more intense on more liquid stocks.
Chart 5: Bid-ask spread across capitalisations
Chart 6: Bid-ask spread and index rank
20
35 35
Small
Small
y = 0,014x + 4,4
18
Mid
Mid
30 30
16
Large
Large
25 25
14
Dec-2013
Dec-2013
Last Main Crisis
12
20 20
Feb-2013
Feb-2013
May-2012
May-2012
10
Aug-2011
Aug-2011
15 15
8
Nov-2010
Nov-2010
6
Jan-2010
Jan-2010
10 10
Apr-2009
Apr-2009
4
Jul-2008
Jul-2008
5 5
2
Oct-2007
Oct-2007
Jan-2007
Jan-2007
0
0 0
0
200
400
600
DJ STOXX 600 rank
Source: Kepler Cheuvreux monthly data from mid-2007 to August 2013 on Stoxx 600
Europe constituents
Source: Kepler Cheuvreux data on Stoxx 600 Europe constituents
Each blue point represents one stock in the index.
Median bid-ask spread (bps)
Median bid-ask spread (bps)
Median bid-ask spread (2013, bps)

Quant Research

Quant Research Bid-ask spreads and historical volatility vary accordingly As we can see in Chart 5,
Bid-ask spreads and historical volatility vary accordingly As we can see in Chart 5, the
Bid-ask spreads and historical volatility vary accordingly
As we can see in Chart 5, the largest bid-ask spreads were observed during the last major
crisis. Currently (Q3 2013), bid-ask spreads are narrower than pre-crisis levels. While large
cap bid-ask spreads are close to mid-2007 levels (from 7 to 5 bps), small cap bid-ask
spreads are down by 5bps (from 15 to 10bps).
Market volatility and market bid-ask spreads evolve with very similar patterns (see Chart 7
below). This well-known characteristic stems from the fact that market makers will ask for
a larger margin (bid-ask spread) when they face a greater market risk (for which volatility is
a good proxy). On the other hand, when the market risk is lower, market makers will be
more inclined to reduce their bid-ask spreads.
A more striking result is the connection between bid-ask spreads, volatility and market
capitalisation. Chart 7 below clearly shows that the smaller the stock, the greater the
impact of volatility on its bid-ask spread. For example, a rise from 20% to 40% in volatility
should increase the bid-ask spread by 4bps for large caps and by 8bps for small caps. The
strong link between volatilities and bid-ask spreads explains much of the bid-ask spread
variability.
Volumes as well as bid-ask spreads show a lot of variability. Market liquidity features
cannot therefore be described by long-term averages alone.
Chart 7: Monthly volumes and volatility
35
Small: spread = 0.4 x volatility + 3
30
Mid
: spread = 0.3 x volatility + 3
Large: spread = 0.2 x volatility + 3
25
20
15
10
5
0
10
20
30
40
50
60
Average intraday volatility (%)
Source: Kepler Cheuvreux monthly data from mid-2007 to August 2013 on Stoxx 600 Europe index
To examine this issue further, see the article from Chordia, Sarkar, and Subrahmanyam “The
joint dynamics of liquidity, returns, and volatility across small and large firms”, Federal Reserve
Bank of New York, Staff Report, 2005.
Median bid-ask spread (bps)

Small cap bid-ask spreads widen earlier in response to volatility increases than is the case for mid and large cap bid-ask spreads

Quant Research

Market impact overview: theory & practice

Based on current liquidity characteristics, market impact models evaluate expected trading costs. In this section, we first present the general properties of market impact models. We then discuss when they are applicable and what to do in practice when assessing the risk of a trading outside the domain of validity of statistical models.

Market impact models share common properties

Model inputs and formula

Market impact models estimate the price impact of a given order. The price impact is

defined as the difference between the last traded share price, and the first traded share

price of the same order (for a buy order). The usual inputs for these models are:

the trading duration (total duration of the trade, expressed in minutes);

the participation rate (transaction size in shares / total number of traded shares

during the same period;

the

(stock’s

transaction, expressed in bps);

bid-ask

spread

average

bid-ask

spread

applicable

during

the

the volatility (some models use volatility although it is possible to work with bid-

ask spreads only, since these two variables are highly correlated, as we saw

earlier).

Our market impact model can be written as follows:

 

(

)

(

)

(

)

Its parameters are estimated on our internal historical executed orders database from

2010.

Main properties

As expected, the estimated market impact increases with the trading duration, the

participation rate and the bid-ask spread. One interesting property of this model is that

trading two different stocks with the same duration and participation rate should lead to

the same market impact expressed in units of bid-ask spreads, as we will see in the

following example.

To get a good overview of the large academic research on this topic, we recommend

Almgren et al., “Equity market impact”, Risk Magazine, July 2005.

“Equity market impact”, Risk Magazine, July 2005 . Calibration with real client orders gives us a

Calibration with real client orders gives us a simple and robust market impact model based only on:

bid-ask spreads, participation rate and trading duration

Quant Research

Example on Deutsche Telekom and Portugal Telecom

Let us consider a standard “percentage of volume” order at 20% participation rate on a 30-

minute duration on Deutsche Telekom (DTE GY). Its average bid-ask spread is 3bps. The

expected market impact would be:

)

= 1.43 DTE GY bid-ask spread

(

)

(

(

)= 4.3 bps

Now let us take a less liquid stock: Portugal Telecom (PTC PL), with an average bid-ask

spread of 7bps. For a standard “percentage of volume” order at 20% participation rate on a

30-minute duration, the expected market impact would be:

(

= 1.43 PTC PL bid-ask spread

)

(

)

(

)= 10.0 bps

Trading with the same participation rate and duration on two different stocks can result in

two different market impacts. But these impacts relative to their stock’s own bid-ask

spread will be the same, as we can see above.

Chart 8 (below) displays the estimated market impact for a given participation rate and

trading duration. The estimates are expressed in bid-ask spreads of the underlying stock.

Thus this single surface shows the estimated market impacts for any stock for a given

duration and participation rate.

Chart 8: Participation rate, duration and estimated market impact

Estimated market impact (20% participation rate, 30 min duration) = 1.43 bid-ask spreads
Estimated market impact
(20% participation rate,
30 min duration) =
1.43 bid-ask spreads

Source: Kepler Cheuvreux

(20% participation rate, 30 min duration) = 1.43 bid-ask spreads Source: Kepler Cheuvreux 10 keplercheuvreux.com

Quant Research

Practical use and model validity

Reality-based model designed for usual trading conditions

Our model is estimated with real executions from 2010. Therefore our forecasts will be much more accurate upon normal trading durations and participation rates. Beyond standard values, statistical inference lacks relevance. In practice, this means that we recommend the use of our model with a participation rate between 0% and 30%, and an execution duration time up to one day execution. Here we can assess the quality of our model. For unusual trading conditions (participation rates above 30% or trading durations exceeding one day) a proper statistical estimation of special market impacts is not achievable since very few transactions occur in such conditions.

Market impact for large participation rates

When participation rates are very large (above 30-35%) trading impacts are particularly hazardous, as traders well know. In such situations, the ongoing trading is likely to be discovered by other market participants. Academics call this phenomenon “information leakage”. Its main consequence is that the order book anticipates aggressive orders and moves accordingly. This may result in a huge market impact, which all traders want to avoid.

For this reason, block trading can be particularly useful in such situations. From a quantitative point of view we recommend not to use a participation rate beyond 30% even if the trading duration should lengthen. This of course generates a higher market risk for the trader but this is usually better than running the risk of market discovery. In such situations, market risk measures should be preferred to market impact forecasts.

In such situations, market risk measures should be preferred to market impact forecasts. 11 keplercheuvreux.com

Quant research

Quant research Measuring liquidity risk on a portfolio Liquidity risk monitoring is a developing field of

Measuring liquidity risk on a portfolio

Liquidity risk monitoring is a developing field of risk management. It comprises several measures: the first measure introduced is trading duration; the second is market impact, which estimates the cost at which the portfolio can be liquidated; and the third is market risk, which computes the risk incurred by the portfolio during trading.

Portfolio liquidity measures for different market contexts

Trading duration analysis

In order to control the liquidity risk of portfolios, most risk managers establish basic risk

guidelines. The most frequent liquidity risk constraint is to limit the size of each portfolio’s

position to a fixed number of trading days given a reasonable participation rate. For

example, a risk limit may state that no position in a portfolio should represent more than 5

normal trading days with a given participation rate of 20%.

At portfolio level, the most common way to analyse liquidity is to study the trading duration

curve. This means, for a given trading duration, representing the percentage of the fund

that can be liquidated within this duration. In the examples below we considered an index

portfolio that replicates the Stoxx Small Caps Europe with EUR100m AUM. This is

illustrated by the dark blue line in the example below (Charts 9 and 10).

Trading duration measures, based on real historical volumes’ distributions, provide robust estimates

To take into account the varying volume contexts that can be encountered, it is useful to

represent not only the average duration curves, but also curves that correspond to adverse

liquidity contexts. For this reason, we used shades of blue to show confidence intervals

around the median trading duration curve in Charts 9 and 10 below.

Chart 9: Trading duration (20% participation rate)

Chart 10: Trading duration (zoom)

(20% participation rate) Chart 10: Trading duration (zoom) Source: Kepler Cheuvreux data from September 2011 to

Source: Kepler Cheuvreux data from September 2011 to August 2013 on Stoxx Small Caps Europe index constituents

Median: +0.6 days 10% worst cases: +0.8 days
Median: +0.6 days
10% worst cases: +0.8 days

Liquidation of 90% of the portfolio

Source: Kepler Cheuvreux data from September 2011 to August 2013 on Stoxx Small Caps Europe index constituents

Quant research

Quant research The curve on the left enables a risk manager to assess the liquidity risk

The curve on the left enables a risk manager to assess the liquidity risk of a portfolio. If we

zoom into the curve, as shown in Chart 10 on the right, we can see that, for example, 90% of

the portfolio would take on average 0.6 days of trading to be liquidated. However, in

adverse situations it might take up to 0.8 days (with a 90% confidence interval

corresponding to the lower part of the shaded blue).

Market impact analysis

Market impact analysis estimates the cost at which the portfolio can be liquidated. This

computation is performed through our market impact model. As we saw earlier in this

study, this estimate is only reliable in normal trading conditions. Thus, when trading

duration remains below one day and participation rate below 30%, the market impact

analysis remains valid.

Market impact measures are estimated with a VaR approach to account for different liquidity contexts

Market impact models take into account trading durations, which are subject to changing

liquidity conditions. This explains why, given the same portfolio, the market impact analysis

may lead to very different results in different contexts. To get a fair estimate of the adverse

liquidity situations one may face, we plotted the histogram of liquidation costs. We can see

in Chart 11 below the historical liquidation costs of a small cap portfolio during the past

two years, with a 20% participation rate. In Chart 12, the corresponding distribution is

plotted with a VaR (10%).

Chart 11: Liquidation market impact over time

a VaR (10%). Chart 11: Liquidation market impact over time Source: Kepler Cheuvreux data from September

Source: Kepler Cheuvreux data from September 2011 to August 2013 on Stoxx Small Caps Europe index constituents

Chart 12: Liquidation market impact distribution

Chart 12: Liquidation market impact distribution Source: Kepler Cheuvreux data from September 2011 to August

Source: Kepler Cheuvreux data from September 2011 to August 2013 on Stoxx Small Caps Europe index constituents

When portfolios are not liquid enough for market impact models to be relevant, eg because

trading durations are too large, then the theoretical results of the expected market impact

should be treated with caution. In such cases, considering the liquidation market risk is a

helpful alternative as it reflects more accurately the risk incurred by the portfolio while it is

being liquidated.

Quant research

Quant research Liquidation market risk The liquidation market risk of a portfolio is the market risk

Liquidation market risk

The liquidation market risk of a portfolio is the market risk incurred during trading.

Our market risk estimates the potential portfolio’s NAV fluctuations incurred during liquidation

The longer the trading duration, the higher the market risk.

The more volatile the market, the higher the market risk, since price variations are

stronger.

To compute precisely the liquidation market risk, one has to estimate each portfolio

component’s trading duration as well as its volatility, and then to compute the result for the

portfolio as a whole.

Chart 13: Liquidation market risk over time

Chart 14: Liquidation market risk distribution

over time Chart 14: Liquidation market risk distribution Source: Kepler Cheuvreux data from September 2011 to

Source: Kepler Cheuvreux data from September 2011 to August 2013 on Stoxx Small Caps index constituents

2011 to August 2013 on Stoxx Small Caps index constituents Source: Kepler Cheuvreux data from September

Source: Kepler Cheuvreux data from September 2011 to August 2013 on Stoxx Small Caps index constituents

The results are displayed in Charts 13 and 14. The left side displays the historical

liquidation market risk estimation. The right side shows the histogram of its historical

distribution. As earlier, the VaR (10%) is represented by a vertical line delimiting the right-

hand side of the distribution tail in Chart 14, the corresponding level is plotted with a

horizontal line in Chart 13. This shows that in 10% of cases, liquidation market risk was

above 1.73%.

AUM and liquidation trading durations

The three different analyses we have just studied are applicable to any portfolio.

Nevertheless, liquidity issues increase with AUM. For example we can see in Chart 15

below that an index fund that replicates the Stoxx Small Caps could liquidate 80% of its

positions (with a 20% participation rate) within 3h25min, 1 day or 2 days for different AUM

(EUR100m, EUR250m and EUR500m).

Quant research

Chart 15: Liquidation trading duration of Stoxx small caps according to AUM

Different Trading Durations for different AUM
Different Trading Durations for different AUM

Source: Kepler Cheuvreux data from September 2011 to August 2013 on Stoxx Small Caps index constituents

Practical applications for future ESMA regulatory framework

New ESMA recommendations on liquidity monitoring

In May 2013 the ESMA (European Securities and Markets Authority) issued a consultation

paper on reporting obligations for alternative funds (under Articles 3 and 24 of the AIFMD,

Alternative Investment Fund Managers Directive). These guidelines should be come into

force in 2014. It is very likely that similar liquidity monitoring will be required for UCITS

funds in the next regulation review.

The mandatory liquidity reporting will need to: “report the percentage of the fund’s portfolio

that is capable of being liquidated within each of the liquidity periods specified. Each investment

should be assigned to one period only and such assignment should be based on the shortest period

during which such a position could reasonably be liquidated at or near its carrying value”. The

reporting frequency is quarterly, biannual or annual depending on the fund’s AUM.

To assess the amount of the portfolio that can be liquidated “at or near its carrying value”, the

use of our market impact model can provide the expected answer. Then in order to

evaluate “the percentage of the fund’s portfolio that is capable of being liquidated within each of

the liquidity periods specifiedthe duration analysis presented earlier will be very helpful to

build and corroborate the new liquidity report required by the ESMA.

corroborate the new liquidity report required by the ESMA. Our different measures help respond to the

Our different measures help respond to the ESMA’s new liquidity risk regulations

Quant research

Practical recommendations

First, liquidity analysis should be conducted using a VaR approach to take into account the

variety of liquidity situations faced in reality. Only such an approach can give a fair idea of

what would happen in adverse situations. VaR computations are widespread for market

risk analysis; they should be equally popular for liquidity risk analysis. Therefore we

recommend the use of a liquidation market impact VaR, as well as a liquidation trading

duration VaR.

Second, in order to put in place the future reporting obligations issued by the ESMA for

alternative funds, we propose rigorous liquidity measures: trading duration, market impact,

and market risk that can help risk managers build the new reports required by future

regulations.

We would be delighted to explain our approach to clients who want us to help them

monitor and estimate their liquidity risk based on our execution experience.

their liquidity risk based on our execution experience. We can help clients put in place the

We can help clients put in place the ESMA’s new reporting using our liquidity risk measures.

Quant research

Notes

Quant research Notes 17 keplercheuvreux.com

Quant Research

Quant Research Legal and disclosure information Copyright © Kepler Cheuvreux, 2013. All rights reserved All prices

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Copyright © Kepler Cheuvreux, 2013. All rights reserved

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KEPLER CHEUVREUX RESEARCH AND DISTRIBUTION

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This communication is confidential and is intended solely for the addressee. It is not to be forwarded to any other person or copied without the permission of the sender. This communication is provided for information only. It is not a personal recommendation or an offer to sell or a solicitation to buy the securities mentioned. Investors should obtain independent professional advice before making an investment.

Notice to U.S. Investors: This material is not for distribution in the United States, except to “major US institutional investors” as defined in SEC Rule 15a-6 ("Rule 15a-6"). Kepler Cheuvreux refers to Kepler Capital Markets, Société anonyme (S.A.) (“Kepler Capital Markets SA”) and its affiliates, including CA Cheuvreux, Société Anonyme (S.A.). Kepler Capital Markets SA has entered into arrangements with Crédit Agricole Cheuvreux North America, Inc. (“CA Cheuvreux North America”) and Kepler Capital Markets, Inc. ("KCM, Inc.") (collectively “US Broker-Dealers”), which enables this report to be furnished to certain U.S. recipients in reliance on Rule 15a-6 through US Broker-Dealers registered under the U.S. Securities Exchange Act of 1934, as amended.

Each U.S. recipient of this report represents and agrees, by virtue of its acceptance thereof, that it is a "major U.S. institutional investor" (as such term is defined in Rule 15a-6) and that it understands the risks involved in executing transactions in such securities. Any U.S. recipient of this report that wishes to discuss or receive additional information regarding any security or issuer mentioned herein, or engage in any transaction to purchase or sell or solicit or offer the purchase or sale of such securities, should contact a registered representative of the US Broker-Dealer that provided the report. Under no circumstance should you direct orders to CA Cheuvreux North America as payment for products or services provided by KCM, Inc. In turn, under no circumstance should you direct orders to KCM, Inc. as payment for products or services provided by CA Cheuvreux North America.

CA Cheuvreux North America is a broker-dealer registered with the Securities and Exchange Commission ("SEC"), a member of the Financial Industry Regulatory Authority ("FINRA"), the New York Stock Exchange ("NYSE"), and the Securities Investor Protection Corporation ("SIPC"). You can reach CA Cheuvreux North America at 1301 Avenue of the Americas, 15th floor, New York, NY 10019, phone (212) 492-8800; Equity trading: (212) 492-8825. Further information is also available at www.cheuvreux.com.

KCM, Inc.is a broker-dealer registered with the SEC, a member of FINRA and SIPC. You can reach KCM, Inc. at 600 Lexington Avenue, New York, NY 10022, phone (212) 710-7606; Equity trading: 212-710-7602. Further information is also available at www.keplercapitalmarkets.com.

You

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Quant Research

Quant Research CA Cheuvreux North America is a wholly owned subsidiary of Crédit Agricole Cheuvreux S.A.

CA Cheuvreux North America is a wholly owned subsidiary of Crédit Agricole Cheuvreux S.A. which is, in turn, owned by Kepler Capital Markets SA. As part of the ownership of Crédit Agricole Cheuvreux S.A., Kepler Capital Markets SA is entitled to distribute certain financial research produced by Crédit Agricole Cheuvreux S.A.

any insured depository institution, may lose value and are not guaranteed by the entity that published the research as disclosed on the front page and are not guaranteed by US Broker-Dealers.

Investing in non-U.S. Securities may entail certain risks. The securities referred to in this report and non-U.S. issuers may not be registered under the U.S. Securities Act of 1933, as amended, and the issuer of such securities may not be subject to U.S. reporting and/or other requirements. Rule 144A securities may be offered or sold only to persons in the U.S. who are Qualified Institutional Buyers within the meaning of Rule 144A under the Securities Act. The information available about non-U.S. companies may be limited, and non-U.S. companies are generally not subject to the same uniform auditing and reporting standards as U.S. companies. Securities of some non-U.S. companies may not be as liquid as securities of comparable U.S. companies. Securities discussed herein may be rated below investment grade and should therefore only be considered for inclusion in accounts qualified for speculative investment.

Analysts employed by Kepler Capital Markets SA, a non-U.S. broker-dealer, are not required to take the FINRA analyst exam. The information contained in this report is intended solely for certain "major U.S. institutional investors" and may not be used or relied upon by any other person for any purpose. Such information is provided for informational purposes only and does not constitute a solicitation to buy or an offer to sell any securities under the Securities Act of 1933, as amended, or under any other U.S. federal or state securities laws, rules or regulations. The investment opportunities discussed in this report may be unsuitable for certain investors depending on their specific investment objectives, risk tolerance and financial position.

In jurisdictions where US Broker-Dealers are not registered or licensed to trade in securities, or other financial products, transactions may be executed only in accordance with applicable law and legislation, which may vary from jurisdiction to jurisdiction and which may require that a transaction be made in accordance with applicable exemptions from registration or licensing requirements.

The information in this publication is based on sources believed to be reliable, but US Broker-Dealers do not make any representation with respect to its completeness or accuracy. All opinions expressed herein reflect the author's judgment at the original time of publication, without regard to the date on which you may receive such information, and are subject to change without notice.

US Broker-Dealers or their affiliates may have issued other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. These publications reflect the different assumptions, views and analytical methods of the analysts who prepared them. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is provided in relation to future performance.

US Broker-Dealers and any company affiliated with it may, with respect to any securities discussed herein: (a) take a long or short position and buy or sell such securities; (b) act as investment and/or commercial bankers for issuers of such securities; (c) act as market makers for such securities; (d) serve on the board of any issuer of such securities; and (e) act as paid consultant or advisor to any issuer. The information contained herein may include forward-looking statements within the meaning of U.S. federal securities laws that are subject to risks and uncertainties. Factors that could cause a company's actual results and financial condition to differ from expectations include, without limitation: political uncertainty, changes in general economic conditions that adversely affect the level of demand for the company's products or services, changes in foreign exchange markets, changes in international and domestic financial markets and in the competitive environment, and other factors relating to the foregoing. All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement.

2. In the United Kingdom, this report is approved and/or distributed by Kepler Capital Markets SAwhich is authorized by the Financial

Conduct Authority (“FCA”).

3. In Italy, this Research is approved and/or distributed by Kepler Capital Markets SA and is not intended for circulation or distribution

either to the public at large or to any other parties other than professional clients and/or qualified counterparties, as defined in Legislative Decree No.58 of 24 February 1998 as amended, and implementing Consob regulations.

4. In Germany this report is approved and/or distributed by Kepler Capital Markets SA.

THE DISTRIBUTION OF THIS DOCUMENT BY KEPLER CAPITAL MARKETS IN OTHER JURISDICTIONS MAY BE RESTRICTED BY LAW, AND PERSONS INTO WHOSE POSSESSION THIS DOCUMENT COMES SHOULD INFORM THEMSELVES ABOUT, AND OBSERVE, ANY SUCH RESTRICTIONS. BY ACCEPTING THIS REPORT YOU AGREE TO BE BOUND BY THE FOREGOING INSTRUCTIONS.

The MSCI indexes are the exclusive property of MSCI Inc. (“MSCI”). MSCI and the MSCI index names are service mark(s) of MSCI or its affiliates and have been licensed for use for certain purposes by KEPLER CHEUVREUX. The financial securities referred to herein are not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such financial securities. The Prospectus contains a more detailed description of the limited relationship MSCI has with KEPLER CHEUVREUX and any related financial securities. No purchaser, seller or holder of this product, or any other person or entity, should use or refer to any MSCI trade name, trademark or service mark to sponsor, endorse, market or promote this product without first contacting MSCI to determine whether MSCI’s permission is required. Under no circumstances may any person or entity claim any affiliation with MSCI without the prior written permission of MSCI.

The Dow Jones GCC IndexSM, or other applicable index, are calculated, distributed and marketed by Dow Jones & Company, Inc., a licensed trademark of CME Group Index Services LLC ("CME"), and have been licensed for use. All content of the Dow Jones IndexesSM © 2012 Dow Jones & Company, Inc.

No part of this report may be reproduced in any manner or redistributed without the prior written permission of Kepler Cheuvreux.

Amsterdam Kepler Cheuvreux Benelux Johannes Vermeerstraat 9

1071 DK Amsterdam

+31 20 573 06 66

Frankfurt

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60325 Frankfurt

+49 69 756960

Geneva Kepler Cheuvreux SA

Route de Crassier 11

1262 - Eysins

Switzerland +41 22361 5151

London

Kepler Cheuvreux UK 12th Floor, Moorhouse

120 London Wall

London EC2Y 5ET +44 20 7621 5100

Madrid

Kepler Cheuvreux Espana Alcala 95

28009 Madrid

+3491 4365100

Milan

Kepler Cheuvreux Italia Corso Europa 2

20122 Milano

+39 02 855 07 1

Paris

Kepler Cheuvreux France

112 Avenue Kleber

75016 Paris

+33 1 53653500

Stockholm

Kepler Cheuvreux Nordic Regeringsgatan 38

10393 Stockholm

+468 723 5100

Vienna Kepler Cheuvreux Vienna Schottenring 16/2 Vienna 1010 +43 1 537 124 147

Zurich Kepler Cheuvreux Switzerland Stadelhoferstrasse 22 Postfach

8024 Zurich

+41 433336666

Stadelhoferstrasse 22 Postfach 8024 Zurich +41 433336666 Local insight, European scale Kepler Cheuvreux has exclusive

Local insight, European scale

8024 Zurich +41 433336666 Local insight, European scale Kepler Cheuvreux has exclusive international distribution

Kepler Cheuvreux has exclusive international distribution rights for UniCredit’s CEE product.

North America

Boston Kepler Capital Markets, Inc 225 Franklin Street, Floor 26 Boston, MA 02110 +1 617-295-01100

New York CA Cheuvreux North America 1301 Avenue of the Americas, Floor 15 New York, NY 10019 +1 212-492-8800

San Francisco Kepler Capital Markets, Inc 50 California Street, Suite 1500 San Francisco, CA 94111 +1 415-255-9802

New York Kepler Capital Markets, Inc. 600 Lexington Avenue, Floor 28 10022 New York, NY USA +1 212-710-7600

Capital Markets, Inc. 600 Lexington Avenue, Floor 28 10022 New York, NY USA +1 212-710-7600 20

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