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Trading Volume, Illiquidity and Commonalities in FX Markets

Angelo Ranaldo () and Paolo Santucci de Magistris ()

No 1823, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: In a regime of floating FX rates and open economies, it is important to understand the way through which FX rates, volatility, and trading volume interrelate. To uncover this, we provide a simple theoretical framework to jointly explore these factors in a multi-currency environment. Through the use of a unique intraday data representative for the global FX market, the empirical analysis validates our theoretical predictions: (i) more disagreement increases FX trading volume, volatility, and illiquidity, (ii) stronger commonalities pertain to more effi cient (arbitrage-free) currencies, and (iii) the Amihud (2002) measure, for which we provide a theoretical underpinning, is effective in measuring FX illiquidity. Not only do these findings support an integrated analysis of FX rate evolution and risk, but our work also offers a straightforward method to measure FX illiquidity and commonality. For investors, these insights should increase the e fficiency of trading and risk analysis. For policy makers, our work highlights the developments of FX global volume, volatility, and illiquidity across time and currencies, which can be important for the implementation of monetary policy and financial stability.

Keywords: FX Trading Volume; Volatility; Illiquidity; Commonalities; Arbitrage (search for similar items in EconPapers)
JEL-codes: C15 F31 G12 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-mst
Date: 2018-11, Revised 2019-10
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