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Global liquidity risk in the foreign exchange market

  • Banti, Chiara
  • Phylaktis, Kate
  • Sarno, Lucio

Using a broad data set of 20 US dollar exchange rates and order flow of institutional investors over 14 years, we construct a measure of global liquidity risk in the foreign exchange (FX) market. Our FX liquidity measure may be seen as the analog of the well-known Pastor–Stambaugh liquidity measure for the US stock market. We show that this measure has reasonable properties, and that there is a strong common component in liquidity across currencies. Finally, we provide evidence that liquidity risk is priced in the cross-section of currency returns, and estimate the liquidity risk premium in the FX market around 4.7 percent per annum.

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File URL: http://www.sciencedirect.com/science/article/pii/S0261560611001732
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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 31 (2012)
Issue (Month): 2 ()
Pages: 267-291

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Handle: RePEc:eee:jimfin:v:31:y:2012:i:2:p:267-291
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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