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
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: Suggested Citation