Trading Volume, Illiquidity and Commonalities in FX Markets
47 Pages Posted: 22 Nov 2018 Last revised: 26 Nov 2018
We provide a unified model for foreign exchange (FX), trading volume, and volatility
in a multi-currency environment. Tied by arbitrage conditions, FX rates are determined
by common information and trader-specific components generating heterogeneous
reservation prices thus inducing trading. Our model outlines new properties including
volume-volatility relationships between direct and synthetic FX rates. It also provides
a theoretical foundation for commonalities of volume, volatility, and illiquidity across
currencies and time, and an intuitive closed-form solution for the price impact measure.
Using unique (intraday) data representative for the global FX spot market, the
empirical analysis validates our theoretical predictions.
Keywords: FX Trading Volume, Volatility, Illiquidity, MDH, Commonalities, Co-Jumps
JEL Classification: C15, F31, G12, G15
Suggested Citation: Suggested Citation