Global liquidity risk in the foreign exchange market

Chiara Banti, Kate Phylaktis and Lucio Sarno

Journal of International Money and Finance, 2012, vol. 31, issue 2, 267-291

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.

Keywords: Foreign exchange; Liquidity; Order flow; Microstructure (search for similar items in EconPapers)
JEL-codes: F31 F37 G12 G15 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (46)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:31:y:2012:i:2:p:267-291

DOI: 10.1016/j.jimonfin.2011.11.010

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