Global liquidity risk in the foreign exchange market

Banti, C., Phylaktis, K. & Sarno, L. (2012). Global liquidity risk in the foreign exchange market. Journal of International Money and Finance, 31(2), pp. 267-291. doi: 10.1016/j.jimonfin.2011.11.010

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Abstract

Using a broad data set of 20 US dollar exchange rates and order flow of institutional investors over 14 years, we construct a measure of global liquidity risk in the foreign exchange (FX) market. Our FX liquidity measure may be seen as the analog of the well-known Pastor–Stambaugh liquidity measure for the US stock market. We show that this measure has reasonable properties, and that there is a strong common component in liquidity across currencies. Finally, we provide evidence that liquidity risk is priced in the cross-section of currency returns, and estimate the liquidity risk premium in the FX market around 4.7 percent per annum.

Item Type: Article
Additional Information: © 2012, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/
Uncontrolled Keywords: Foreign exchange; Liquidity; Order flow; Microstructure
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Finance
URI: http://openaccess.city.ac.uk/id/eprint/13160

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