Liquidity Coverage Ratio and Lognormally distributed share returns: Difference between pages

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''Bank regulation''
If share returns are lognormally distributed it means that the logarithm of [1 + the share return] has a normal probability distribution.


(LCR).
Normal distributions have infinitely long ‘tails’ both upside and downside - so implying unlimited downside potential when used for modelling share returns.  


The LCR is a requirement under Basel III for a bank to hold high-quality liquid assets (HQLAs) sufficient to cover 100% of its stressed net cash requirements over 30 days.
But the theoretically worst outcome for a share investor is to lose the whole of their investment - in other words a negative return of -100%. It is not theoretically possible to suffer a return of worse than -100%.
 
 
The purpose of this requirement is to ensure that banks can manage stressed market conditions, under which the bank is assumed to suffer substantial outflows of the cash previously deposited with it.
 
The LCR applies throughout the European Union.
 
The LCR has been implemented in stages from 2015, to reach the 100% requirement by January 2019.  
 
 
It reduces the value to a bank of cash deposits of less than 30 days tenor, because they are only worth the income on the HQLAs if a bank forecasts no short term cash receipts to cover repayment.  


Lognormal distributions - unlike normal distributions - also have a limited downside, so they do not suffer from this theoretical shortcoming.


== See also ==
== See also ==
* [[Basel III]]
* [[Lognormal frequency distribution]]
* [[European Union]]
* [[Normal distribution]]
* [[Net Stable Funding Ratio]]
* [[Volatility]]
* [[Cash investing in a new world]]
* [[HQLA]]
* [[Level 1 liquid assets]]
* [[Level 2 liquid assets]]
* [[Leverage Ratio]]
* [[Liquidity buffer]]
* [[Liquidity risk]]
* [[LR]]
* [[OLAR]]
* [[Pillar 1]]
* [[Required Stable Funding]]
* [[Stress]]
* [[Survival period]]


[[Category:Compliance_and_audit]]
[[Category:Liquidity_management]]

Revision as of 14:20, 23 October 2012

If share returns are lognormally distributed it means that the logarithm of [1 + the share return] has a normal probability distribution.

Normal distributions have infinitely long ‘tails’ both upside and downside - so implying unlimited downside potential when used for modelling share returns.

But the theoretically worst outcome for a share investor is to lose the whole of their investment - in other words a negative return of -100%. It is not theoretically possible to suffer a return of worse than -100%.

Lognormal distributions - unlike normal distributions - also have a limited downside, so they do not suffer from this theoretical shortcoming.

See also