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Liquidity Risk

The risk that a financial market entity will not be able to find a price (or a price within a reasonable tolerance in terms of the deviation from prevailing or expected prices) for one or more of its financial contracts in the secondary market. Consider the case of a counterparty who buys a complex option on European interest rates. He is exposed to liquidity risk because of the possibility that he cannot find anyone to make him a price in the secondary market and because of the possibility that the price he obtains is very much against him and the theoretical price for the product.