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Liquidity Risk - Relevance to Actuaries [34]

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Bullet points include: Two otherwise identical firms, A and B: Larger line (constituting bulk of the firms’ overall risk). Both A and B have the same assets and liabilities. Assumed not exposed to liquidity risk (e.g. liquid unit-linked). Smaller line: involves highly illiquid liabilities (e.g. annuity book): Same liabilities. A invests in illiquid assets arguing that these best match the illiquid nature of the liabilities. B invests in liquid assets with similar cash flow timings. Which should the policyholder prefer? In other words, what credit should we allow for the illiquidity premium potentially available on illiquid assets?

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