Liquidity in the foreign exchange market: Measurement, commonality, and risk premiums

Loriano Mancini, Angelo Ranaldo, Jan Wrampelmeyer

Research output: Contribution to JournalArticleAcademicpeer-review

Abstract

We provide the first systematic study of liquidity in the foreign exchange market. We find significant variation in liquidity across exchange rates, substantial illiquidity costs, and strong commonality in liquidity across currencies and with equity and bond markets. Analyzing the impact of liquidity risk on carry trades, we show that funding (investment) currencies offer insurance against (exposure to) liquidity risk. A liquidity risk factor has a strong impact on carry trade returns from 2007 to 2009, suggesting that liquidity risk is priced. We present evidence that liquidity spirals may trigger these findings.

Original languageEnglish
Pages (from-to)1805-1841
Number of pages37
JournalThe Journal of Finance
Volume68
Issue number5
DOIs
Publication statusPublished - Oct 2013

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Risk premium
Liquidity
Liquidity risk
Commonality
Foreign exchange market
Carry trade
Currency
Illiquidity
Bond market
Trigger
Risk factors
Insurance
Exchange rates
Funding
Equity markets
Costs
Trade shows

Cite this

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Liquidity in the foreign exchange market : Measurement, commonality, and risk premiums. / Mancini, Loriano; Ranaldo, Angelo; Wrampelmeyer, Jan.

In: The Journal of Finance, Vol. 68, No. 5, 10.2013, p. 1805-1841.

Research output: Contribution to JournalArticleAcademicpeer-review

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