Exchange Rates and Liquidity Risk

37 Pages Posted: 20 Oct 2020

See all articles by Martin D.D. Evans

Martin D.D. Evans

Georgetown University - Department of Economics

Date Written: August 31, 2020

Abstract

I use Forex trading data to study how risks associated with the lack of liquidity contribute to the dynamics of 17 spot exchange rates through their time-varying contributions to risk premia. I find that liquidity risk matters. All the foreign exchange risk premia compensate investors for exposure to liquidity risk; and, for many currencies, exposure to liquidity risk appears to be more important than exposure to the traditional carry and momentum risk factors. I also find that variations in the price of liquidity risk make economically important contributions to the behavior of individual foreign currency returns: they account for approximately 34 percent, on average, of the variability in currency returns compared to the contribution of approximately 8 percent from the prices of carry and momentum risk.

Keywords: Foreign Currency Trading, Liquidity, Returns, Risk Premia, and Risk Factors

JEL Classification: F3; F4; G1

Suggested Citation

Evans, Martin D.D., Exchange Rates and Liquidity Risk (August 31, 2020). Available at SSRN: https://ssrn.com/abstract=3684060 or http://dx.doi.org/10.2139/ssrn.3684060

Martin D.D. Evans (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-1570 (Phone)
202-687-6102 (Fax)

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