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Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums

Loriano Mancini, Angelo Ranaldo () and Jan Wrampelmeyer ()

No 2010-03, Working Papers from Swiss National Bank

Abstract: This paper develops a liquidity measure tailored to the foreign exchange (FX) market, quantifies the amount of commonality in liquidity across exchange rates, and determines the extent of liquidity risk premiums embedded in FX returns. The new liquidity measure utilizes ultra high frequency data and captures cross-sectional and temporal variation in FX liquidity during the financial crisis of 2007-2008. Empirical results show that liquidity co-moves across currency pairs and that systematic FX liquidity decreases dramatically during the crisis. Extending an asset pricing model for FX returns by the novel liquidity risk factor suggests that liquidity risk is heavily priced.

Keywords: foreign exchange market; measuring liquidity; commonality in liquidity; liquidity risk premium; subprime crisis (search for similar items in EconPapers)
JEL-codes: F31 G01 G12 G15 (search for similar items in EconPapers)
Date: 2010
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Related works:
Journal Article: Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums (2013) Downloads
Working Paper: Liquidity in the Foreign Exchange Market: Measurement, Commonality,and Risk Premiums (2009) Downloads
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