Liquidity risk arises when an analyst or investor cannot sell or buy an asset quickly without a significant reduction in price. For example, investments in niche markets or illiquid assets such as real estate are very difficult to sell during times of market downturn, hence locking capital and suffering losses.
How to Manage It: Liquidity risk can be managed by maintaining a balanced level of liquid and illiquid assets in portfolios. For example, liquid assets include stocks or bonds that can quickly be converted into cash when a firm is facing financial stress. Developing an emergency liquidity plan which would provide access to credit lines or reserve funds further help manage short-term obligations without having to sell the asset at a loss.