Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums
AbstractThis 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.
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Bibliographic InfoPaper provided by Swiss National Bank in its series Working Papers with number 2010-03.
Length: 65 pages
Date of creation: 2010
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More information through EDIRC
Foreign Exchange Market; Measuring Liquidity; Commonality in LiquidityLiquidity Risk Premium; Subprime Crisis;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G01 - Financial Economics - - General - - - Financial Crises
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
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