What is a liquidity risk?

Liquidity risk refers specifically to the possibility that an investor will not be able to quickly sell an asset without causing a significant decrease in its price. This risk arises in markets where there aren't enough buyers and sellers to facilitate swift transactions, meaning that when an investor needs to sell an asset, they may have to accept a lower price than expected due to the lack of demand.

This situation frequently happens in markets for less liquid assets, where trades are infrequent, or in volatile environments where market sentiment can quickly change. For instance, real estate is often cited as an illiquid asset because property sales can take time and may require price concessions to expedite a sale.

Understanding liquidity risk is critical for investors because it impacts their ability to access cash quickly and can affect their overall investment strategy, especially in times of market stress or when immediate funding is necessary. The other options address different aspects of investment risk but do not specifically capture the essence of liquidity risk.