In other words, these models assume complete illiquidity throughout a stated holding period. Another widely used, but more sophisticated, approach that takes account of liquidity risk is stress testing. Unlike value-at-risk models, which usually assume normal market conditions, stress tests help to quantify how much a firm could lose in unusual or stressful scenarios.
A typical stress scenario incorporates extremely large shocks of the kind that are almost always associated with reduced market liquidity. In sophisticated cases, these scenarios can be dynamic in that they account for likely changes in the firms’ positions.