Understanding FX Liquidity

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

Karnaukh, Nina and Ranaldo, Angelo and Söderlind, Paul, Understanding FX Liquidity (February 23, 2015). Forthcoming in The Review of Financial Studies, University of St.Gallen, School of Finance Research Paper No. 2013/15, Available at SSRN: https://ssrn.com/abstract=2329738 or http://dx.doi.org/10.2139/ssrn.2329738