Liquidity Risk Factor (LRF)
Having computed the PRF, VRF and beta, the protocol then measures its liquidity risk. We first develop a set of Liquidity Ratios, alpha_(w, k, t), which encode the protocol’s liquidity (i.e. balances of assets and capital) with the protocol liabilities: B, L, D, and E :
Next, we develop a corresponding set of targets for liquidity adequacy, known as the Liquidity Reference Ratios. These are also derived from Beta, the “Probability of Claim” for Taker positions in aggregate.
The Liquidity Reference Ratios, r_(w, *, t) for the protocol are:
The Liquidity Reference Ratios are a set of four linear functions that provide a safe operating band (“passband”) for the protocol’s liquidity. Liquidity within this band is considered adequate. The Liquidity Ratios are compared with their reference to determine whether the currently measured protocol liquidity falls within this band. Deviations from these targets serve to increase the Premium, whereas significant deviations may trigger a rebalancing swap to be made between the pools, which aims to manage inventory risk between the Asset and Capital sides of the protocol.
LIQUIDITY RISK VECTORS
A set of Liquidity Risk Vectors are then developed based on the difference between the Liquidity Ratio and its Reference:
Finally, we produce the Liquidity Risk Factor (LRF) from the component Liquidity Risk Vectors, w_(k, t) in W:
The tables below provide a summary of calculating the Liquidity Risk Vectors and a corresponding set of indicative values.
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