Liquidity in FX spot and forward markets

Ingomar Krohn () and Vladyslav Sushko
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Ingomar Krohn: University of Warwick

No GRU_2017_019, GRU Working Paper Series from City University of Hong Kong, Department of Economics and Finance, Global Research Unit

Abstract: This paper assesses liquidity conditions in foreign exchange (FX) spot and derivatives markets using intra-day data for a period after the global financial crisis. Given that FX forwards and swap markets are by some measures even deeper that the spot market, an assessment of FX liquidity requires taking such instruments into account. We find that spot and forward market liquidity is intimately linked. Furthermore, the co-movement between FX funding and market liquidity, as gleaned from the pricing of both types of instruments, has increased over time. This development is tied to dealer balance sheet capacity. While top dealers dominate liquidity provision in spot through- out the sample period, they tend to pull back from market-making in FX forwards and swaps around regulatory reporting periods. This has shifted market-making activity in FX derivatives onto smaller, more expensive and less informed, dealers, and has also resulted in adverse spillovers to liquidity conditions in spot markets.

Keywords: Foreign Exchange; Market liquidity; Funding liquidity; Microstructure; Dealer activity (search for similar items in EconPapers)
JEL-codes: F31 G15 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2017-12-11
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