Measuring Corporate Liquidity Risk

Cash Flow-at-Risk (CFaR) is a risk measure that conveys information on the shortfall in
cash flow, associated with a certain probability, a firm could experience over a certain time
period. However, to provide information on outcomes that are identified as costly by the
risk management literature, in particular underinvestment due to financing constraints, a
risk measure needs to make explicit reference to the firm’s presumed access to external
sources of funding. What is called for is thus a framework in which cash flow-based
measures of risk are conditional on the firm’s debt capacity. The group of risk measures
presented in this paper incorporates this information. They render hedgeable magnitudes
that can inform risk management strategies by indicating if a hedge is likely to mitigate
costly consequences of volatility by acting as a substitute for equity capital.