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FX market liquidity, funding constraints and capital

Phylaktis, K. & Banti, C. (2014). FX market liquidity, funding constraints and capital. Journal of International Money and Finance: theoretical and empirical research in international economics and finance, 56, pp. 114-134. doi: 10.1016/j.jimonfin.2014.11.002


We investigate the determinants of the time variation of the common component of FX market liquidity across developed and emerging market currencies. We study the impact of funding liquidity constraints, which proxy for supply considerations, and capital flows, which proxy for demand considerations of liquidity on transaction costs. Our results show that (i) funding liquidity constraints measured by the availability of outstanding repos reduce FX market liquidity, and their impact is stronger when they are associated with an increase in the costs of funding and a shortening of their maturity; (ii) increasing capital flows at the global level increase liquidity; (iii) both of these effects were stronger during the recent financial crisis, when liquidity dry-ups were severe; and (iv) the analysis of individual currencies with diverse riskiness confirms that a shock to speculator capital would lead to a reduction in market liquidity through a spiral effect that is stronger for more volatile currencies. Furthermore, we find a similar effect related to capital flows

Publication Type: Article
Additional Information: © 2014, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International
Publisher Keywords: Foreign exchange; Liquidity; Funding liquidity constraints; Capital flows; Microstructure
Subjects: H Social Sciences > HG Finance
Departments: Bayes Business School > Finance
Text - Accepted Version
Available under License : See the attached licence file.

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