Thefactors that impact an asset’s liquidation cost include time horizon,asset type, fungibility (i.e., how easy can we sell or replace theasset?), market microstructure and the bid-ask spread:
KevinDowd divides models into three types: fundamental, descriptive, andstatistical. A key theme in the Dowd reading is epistemological: whenwe apply a model, we cannot escape making an assumption. We may choose between assumption trade-offs, but no model can escape reliance on some a priori, unverified assumption. The point is to at least be aware of your assumptions!
TheRebonato reading is short but non-trivial. Rebonato’s definition ofmodel risk: the risk of a significant difference between themark-to-market model value (i.e., what value does the model give us,currently?) and the traded price (what price is the market giving?):
