FX Spot and Swap Market Liquidity and the Effects of Window Dressing

56 Pages Posted: 28 Dec 2017  

Ingomar Krohn

University of Warwick - Finance Group

Vladyslav Sushko

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: December 22, 2017

Abstract

This paper assesses liquidity conditions in foreign exchange (FX) spot and derivatives markets using intra-day data against the background of FX dealers' response to recent regulatory changes. Given that FX swap markets are by some measures even deeper that the spot market, an assessment of FX liquidity requires taking such instruments into account. We find that spot and swap market liquidity is intimately linked. Furthermore, the co-movement between FX funding and market liquidity, as gleaned from the pricing of both types of instruments, has increased over time. This development relates to dealer balance sheet capacity. While top dealers continue to dominate liquidity provision in spot, they tend to pull back from market making in FX swaps around regulatory reporting periods. This shifts market-making activity in FX derivatives towards smaller, more expensive and less informed, dealers, and also results in adverse spillovers to liquidity conditions in spot markets.

Keywords: Foreign Exchange, Market liquidity, Funding liquidity, Microstructure, Dealer activity, Window dressing

JEL Classification: F31, G15

Suggested Citation

Krohn, Ingomar and Sushko, Vladyslav, FX Spot and Swap Market Liquidity and the Effects of Window Dressing (December 22, 2017). WBS Finance Group Research Paper. Available at SSRN: https://ssrn.com/abstract=3092248 or http://dx.doi.org/10.2139/ssrn.3092248

Ingomar Krohn

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

Vladyslav Sushko (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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