Technical hedges of index fund liquidity risk

In markets where index funds are a feasible investment channel, investors can undertake strategies to hedge their position in such funds.

1. Investor, depending on their bargain power, may require installment of liquidity reserve. An increasingly popular calculation of a reserve is with Value at Risk (VaR). Reserve = VaR * multiplier

The more volatile the market is expected to be, the higher the multiplier is used.

Read more of VaR on JP Morgan and Benninga & Wiener 1998 ¹.

2. The position can be further hedged by entering a credit default swap.

Given these instruments, further concern of index fund service provider liquidity risk (default event on the commitment to investors when index rockets) might be attributed to other factors beyond the scope of this technical argument.

¹ Benninga S. and Wiener Z., 1998, ‘Value-at-Risk (VaR)’, Mathematica in Education and Research, vol. 7 no. 4, 1998