Understanding FX Liquidity
Forthcoming in The Review of Financial Studies
University of St.Gallen, School of Finance Research Paper No. 2013/15
49 Pages Posted: 24 Sep 2013 Last revised: 9 Jun 2015
Date Written: February 23, 2015
Abstract
We provide a comprehensive study of the liquidity of spot foreign exchange (FX) rates over more than two decades and a large cross-section of currencies. First, we show that FX liquidity can be accurately measured with daily and readily-available data. Second, we demonstrate that FX liquidity declines with funding constraints and global risk, supporting theoretical models relating funding and market liquidity. In these distressed circumstances, liquidity tends to evaporate more for developed and riskier currencies. Finally, we show stronger comovements of FX liquidities in distressed markets, especially when funding is constrained, volatility is high, and FX speculators incur losses.
The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2614853
Keywords: exchange rates, liquidity, transaction costs, commonality, low-frequency
JEL Classification: C15, F31, G12, G15
Suggested Citation: Suggested Citation