We are independent & ad-supported. We may earn a commission for purchases made through our links.

Advertiser Disclosure

Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.

How We Make Money

We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently from our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.

What is Liquidity Risk?

Geri Terzo
By Geri Terzo
Updated May 17, 2024
Our promise to you
WiseGEEK is dedicated to creating trustworthy, high-quality content that always prioritizes transparency, integrity, and inclusivity above all else. Our ensure that our content creation and review process includes rigorous fact-checking, evidence-based, and continual updates to ensure accuracy and reliability.

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

Editorial Standards

At WiseGEEK, we are committed to creating content that you can trust. Our editorial process is designed to ensure that every piece of content we publish is accurate, reliable, and informative.

Our team of experienced writers and editors follows a strict set of guidelines to ensure the highest quality content. We conduct thorough research, fact-check all information, and rely on credible sources to back up our claims. Our content is reviewed by subject matter experts to ensure accuracy and clarity.

We believe in transparency and maintain editorial independence from our advertisers. Our team does not receive direct compensation from advertisers, allowing us to create unbiased content that prioritizes your interests.

Liquidity risk in the financial markets represents the lack of trading volume in a particular security or asset, a situation that could make it difficult for an investor to make a transaction involving that security or asset when desired. It also refers to the speed at which a company can convert assets, including property, certificates of deposit and investments in stocks and bonds into cash. Without access to proper liquidity, investors, money managers and corporations can become cash-strapped and experience severe setbacks, especially during times of a market downturn.

One measure of liquidity risk is the spread between an asset's bid and ask price. A bid represents what buyers of an asset are willing to pay, and the ask price signifies the most recent price at which a seller was willing to unload the asset. The spread is the difference between the bid and the ask. A widening bid-ask spread represents a larger difference between buyers and sellers, which indicates reduced liquidity.

In the stock and bond markets, the risk surround liquidity is the possibility that there will be only one party, either a buyer or a seller, committed to a trade. For instance, if a trader is seeking to unload a security but no investor is interested in taking the other side of that trade, the trader runs the risk of losing profits or worse, experiencing a loss. Liquidity risk is most prevalent in thinly traded securities because there is little buying and selling activity occurring in these assets at the onset.

A stock's liquidity also determines volatility, or erratic price movements in that security. Widely traded stocks are considered a liquid investment. They can withstand large trading volumes or block trades initiated by institutional investors without demonstrating too much volatility. Thinly traded stocks, however, are a more illiquid investment. These stocks will demonstrate more volatility in the event there is an institutional-size trade in that security.

Individual investors might rely on liquidity for their livelihood. If an investor's retirement portfolio is 100 percent invested in equities, for instance, he or she will depend on selling those stocks in order to generate cash flow. The liquidity risk lies in the possibility that the financial markets will be experiencing a downturn when the time comes to sell the securities, and the investor will be left with little or no access to cash.

Fund managers, including hedge fund managers, often trade in highly complex and sometimes illiquid assets and therefore are exposed to liquidity risk. For this reason, hedge funds often require that investors agree to a lock-up period, which means that they must commit capital to a fund for a period of a year or more before requesting withdrawals. A surge of withdrawal requests can serve as a type of a "run on the bank" for a hedge fund, and if a manager is unable to liquidate assets, he might be forced to close down.

WiseGEEK is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.

Discussion Comments

By burcidi — On Jan 30, 2014

Not only investors, but financial institutions also experience liquidity risk. I work in a bank and the director of our bank approves assets with himself. The major thing he looks at is liquidity risk. He tries to approve assets which carry the leas risk. Otherwise, if the market conditions change abruptly, the bank could lose a lot of money. It could even go bankrupt.

By ZipLine — On Jan 29, 2014

@fBoyle-- An asset is not illiquid when an investor purchases it. The asset usually becomes illiquid later on due to the state of the market. Suddenly, there may be a lack of need for that asset, the asset may lose value and it might be difficult to find buyers. Even if the asset is sold, the owner will have to reduce its price and so will lose money.

The economic market can be unpredictable and it's not easy to know how every sector is going to be influenced by various changes. Of course, investors do risk analysis and I'm sure that they try to have some liquid assets in addition to their illiquid assets. But the only liquid assets that cannot become illiquid are cash and gold. For everything else, liquidity is at risk.

By fBoyle — On Jan 29, 2014

Why in the world do investors buy illiquid assets and put themselves in risk like this? Why don't they keep some liquid assets for emergencies? Don't they do risk analysis before investing?

WiseGEEK, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGEEK, in your inbox

Our latest articles, guides, and more, delivered daily.