Liquidity Risk
Liquidity risk is the risk that an investor cannot sell an asset quickly at a fair price when they need to. Marks treats liquidity as transient and paradoxical: it is usually plentiful when investors do not care about it and scarce when they need it most.
Why It Gets Mispriced
Liquidity is easy to underappreciate because it looks abundant right before it disappears. In calm markets, investors price assets as if exits will always be available. In stress, dealers step back, leverage tightens, redemption pressure rises, and the apparent exit door narrows for everyone at once.
Typical Failure Pattern
- Holders assume they can sell whenever needed.
- Market structure depends on normal conditions.
- Stress hits and many holders want out at once.
- Financing support weakens.
- Sales must happen regardless of price.
- "Liquid" vehicles reveal the illiquidity of their underlying assets.
This is why Marks warns that a daily-trading vehicle cannot truly be more liquid than what it owns.
Practical Rule
Prepare for illiquidity by owning assets that can be held through stress, using structures that allow patience, avoiding fragile leverage, and refusing to confuse quoted liquidity with durable liquidity.
Liquidity risk belongs naturally with credit-cycle because disappearing funding is often what turns a valuation problem into a solvency crisis.