Global Liquidity Risk in the Foreign Exchange Market

50 Pages Posted: 4 Nov 2011

See all articles by Chiara Banti

Chiara Banti

University of Essex

Kate Phylaktis

City University London - Sir John Cass Business School

Lucio Sarno

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Date Written: October 11, 2011

Abstract

Using a broad data set of 20 US dollar exchange rates and order flow of institutional investors over 14 years, we construct a measure of global liquidity risk in the foreign exchange (FX) market. Our FX liquidity measure may be seen as the analogue of the well-known Pastor-Stambaugh liquidity measure for the US stock market. We show that this measure has reasonable properties, and that there is a strong common component in liquidity across currencies. Finally, we provide evidence that liquidity risk is priced in the cross-section of currency returns, and estimate the liquidity risk premium in the FX market around 4.7 percent per annum.

Keywords: foreign exchange, liquidity, order flow, microstructure

JEL Classification: F31, F37, G12, G15

Suggested Citation

Banti, Chiara and Phylaktis, Kate and Sarno, Lucio, Global Liquidity Risk in the Foreign Exchange Market (October 11, 2011). Available at SSRN: https://ssrn.com/abstract=1954749 or http://dx.doi.org/10.2139/ssrn.1954749

Chiara Banti

University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Kate Phylaktis (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom
+44 20 70408735 (Phone)
+44 20 70408881 (Fax)

HOME PAGE: http://www.cass.city.ac.uk/faculty/k.phylaktis/

Lucio Sarno

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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