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FX spot and swap market liquidity spillovers

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  • Krohn, Ingomar
  • Sushko, Vladyslav

Abstract

We study the joint evolution of foreign exchange (FX) spot and swap market liquidity. We find strong co-movement in spot and swap market liquidity conditions and a robust link between FX funding and market liquidity, as gleaned from the pricing of both instruments. This link has strengthened over time. Dealing desks of globally systemically important banks periodically pull back from pricing FX swaps, particularly those that operate closer to regulatory capital or liquidity minimums. While wider spreads attract smaller dealers, liquidity in FX swaps remains impaired, which leads to illiquidity spillovers to the spot market. Our findings suggest that funding liquidity has become a more important driver of spot market liquidity than it used to be.

Suggested Citation

  • Krohn, Ingomar & Sushko, Vladyslav, 2022. "FX spot and swap market liquidity spillovers," Journal of International Money and Finance, Elsevier, vol. 120(C).
    • Handle: RePEc:eee:jimfin:v:120:y:2022:i:c:s0261560621001273
    DOI: 10.1016/j.jimonfin.2021.102476
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    Cited by:

    1. Cerutti, Eugenio M. & Obstfeld, Maurice & Zhou, Haonan, 2021. "Covered interest parity deviations: Macrofinancial determinants," Journal of International Economics, Elsevier, vol. 130(C).
    2. Joseph, Andreas & Vasios, Michalis, 2022. "OTC Microstructure in a period of stress: A Multi-layered network approach," Journal of Banking & Finance, Elsevier, vol. 138(C).
    3. Syrstad, Olav & Viswanath-Natraj, Ganesh, 2022. "Price-setting in the foreign exchange swap market: Evidence from order flow," Journal of Financial Economics, Elsevier, vol. 146(1), pages 119-142.
    4. Leonie Bräuer & Harald Hau, 2022. "Can Time-Varying Currency Risk Hedging Explain Exchange Rates?," Swiss Finance Institute Research Paper Series 22-77, Swiss Finance Institute.
    5. Michael Frömmel & Eyup Kadioglu, 2023. "Impact of trading hours extensions on foreign exchange volatility: intraday evidence from the Moscow exchange," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-23, December.
    6. Pēteris Kloks & Patrick McGuire & Angelo Ranaldo & Vladyslav Sushko, 2023. "Bank positions in FX swaps: insights from CLS," BIS Quarterly Review, Bank for International Settlements, September.

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    More about this item

    Keywords

    Foreign Exchange; Market and funding liquidity; Microstructure; Dealer activity; Window dressing;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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