Illiquidity in the Stock and FX Markets: An Investigation of Their Cross-Market Dynamics

Essex Finance Centre Working Paper Series 12/2015

39 Pages Posted: 17 Jun 2015 Last revised: 16 Dec 2015

Date Written: March 1, 2015

Abstract

This paper investigates the illiquidity channel linking the stock and FX markets. The evidence of co-movement and cross-market spillovers is supportive of important dynamics in illiquidity, especially during the recent crisis. To clarify the nature of these dynamics, I consider the role of two important players on both markets, institutional investors and dealers. Overall, I show that correlated institutional trading contributes to liquidity across markets. Furthermore, as funding availability reduces in times of crisis, dealers' funding constraints affect the observed dynamics. Finally, I find that both correlated institutional trading and dealers' funding constraints are potential triggers of systemic illiquidity spirals.

Keywords: liquidity, cross-market spillovers, funding constraints, institutional investors

JEL Classification: G15, G20

Suggested Citation

Banti, Chiara, Illiquidity in the Stock and FX Markets: An Investigation of Their Cross-Market Dynamics (March 1, 2015). Essex Finance Centre Working Paper Series 12/2015. Available at SSRN: https://ssrn.com/abstract=2619379 or http://dx.doi.org/10.2139/ssrn.2619379

Chiara Banti (Contact Author)

University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

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