Erik Grahn and Jonas Rodling

Estimating liquidation value - a framework for determining haircut on equity collateral

Abstract

The aim of this thesis is to investigate how to determine the appropriate
haircut on equity collateral. We adopt a model developed by Almgren and
Chriss (2000) for stock price movements that takes into account the market
impact effects from an investor's trading. Using this framework we develop
a method for estimating the potential loss from liquidating a large
singlestock portfolio. The method produces a liquidity adjusted Value at Risk
which takes into account both the market risk during the liquidation and
the market impact costs from trading. Our results show that the method is
able to capture liquidity characteristics for different single-stock
portfolios. We conclude that our framework is useful for evaluating the quality of
equity collateral. It is an effective tool for practitioners in determining
haircuts for collateralized loans.