FX Spot and Swap Market Liquidity Spillovers
65 Pages Posted: 28 Dec 2017 Last revised: 25 Jun 2021
Date Written: January 13, 2020
We study the joint evolution of foreign exchange (FX) spot and swap market liquidity. Trading in FX swaps exceeds that of spot, yet this market segment has been largely ignored in prior research on liquidity in FX markets. We find strong co-movement in spot and swap market liquidity conditions and a strong link between FX funding and market liquidity, as gleaned from the pricing of both instruments. This link has strengthened over time with changes in dealer behaviour. Some of the largest dealers periodically pull back from pricing FX swaps and wider spreads attract smaller dealers. At the same time, liquidity in FX swaps remains impaired, which leads to adverse illiquidity spillovers to the spot market. Our findings suggest that funding liquidity has become a more important driver of spot market liquidity than it used to be.
Keywords: Foreign Exchange, Market liquidity, Funding liquidity, Microstructure, Dealer activity, Window dressing
JEL Classification: F31, G15
Suggested Citation: Suggested Citation