IDEAS home Printed from https://ideas.repec.org/p/esy/uefcwp/15626.html
   My bibliography  Save this paper

Illiquidity in the stock and FX markets: an investigation of their cross-market dynamics

Author

Listed:
  • Banti, C

Abstract

In this paper, I investigate the illiquidity channel linking the stock and FX markets.The evidence of co-movement and cross-market spillovers is supportive of important dynamics in illiquidity, especially during the recent crisis. To clarify the nature of these dynamics, I consider the role of two important players on both markets, institutional investors and dealers. Overall, correlated institutional trading contributes to liquidity across markets. Furthermore, as funding availability reduces in times of crisis, dealers' funding constraints affect the observed dynamics. Finally, both correlated institutional trading and dealers' funding constraints are potential triggers of systemic illiquidity spirals.

Suggested Citation

  • Banti, C, 2015. "Illiquidity in the stock and FX markets: an investigation of their cross-market dynamics," Essex Finance Centre Working Papers 15626, University of Essex, Essex Business School.
    • Handle: RePEc:esy:uefcwp:15626
    as

    Download full text from publisher

    File URL: https://repository.essex.ac.uk/15626/
    File Function: original version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Harald Hau & Massimo Massa & Joel Peress, 2010. "Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change," The Review of Financial Studies, Society for Financial Studies, vol. 23(4), pages 1681-1717, April.
    2. Melvin, Michael & Taylor, Mark P., 2009. "The crisis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 28(8), pages 1317-1330, December.
    3. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    4. Bartov, Eli & Bodnar, Gordon M. & Kaul, Aditya, 1996. "Exchange rate variability and the riskiness of U.S. multinational firms: Evidence from the breakdown of the Bretton Woods system," Journal of Financial Economics, Elsevier, vol. 42(1), pages 105-132, September.
    5. Paul A. Gompers & Andrew Metrick, 2001. "Institutional Investors and Equity Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(1), pages 229-259.
    6. Tarun Chordia & Richard Roll & Avanidhar Subrahmanyam, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, vol. 56(2), pages 501-530, April.
    7. Gur Huberman & Dominika Halka, 2001. "Systematic Liquidity," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(2), pages 161-178, June.
    8. Giovanni Cespa & Thierry Foucault, 2014. "Illiquidity Contagion and Liquidity Crashes," The Review of Financial Studies, Society for Financial Studies, vol. 27(6), pages 1615-1660.
    9. Nina Karnaukh & Angelo Ranaldo & Paul Söderlind, 2015. "Understanding FX Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 28(11), pages 3073-3108.
    10. Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(4), pages 1215-1256.
    11. Andrei Shleifer & Robert Vishny, 2011. "Fire Sales in Finance and Macroeconomics," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 29-48, Winter.
    12. Banti, Chiara & Phylaktis, Kate & Sarno, Lucio, 2012. "Global liquidity risk in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 31(2), pages 267-291.
    13. Chung, Kee H. & Zhang, Hao, 2014. "A simple approximation of intraday spreads using daily data," Journal of Financial Markets, Elsevier, vol. 17(C), pages 94-120.
    14. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    15. Banti, Chiara & Phylaktis, Kate, 2015. "FX market liquidity, funding constraints and capital flows," Journal of International Money and Finance, Elsevier, vol. 56(C), pages 114-134.
    16. Dagfinn Rime & Andreas Schrimpf, 2013. "The anatomy of the global FX market through the lens of the 2013 Triennial Survey," BIS Quarterly Review, Bank for International Settlements, December.
    17. Viral V. Acharya & S. Viswanathan, 2011. "Leverage, Moral Hazard, and Liquidity," Journal of Finance, American Finance Association, vol. 66(1), pages 99-138, February.
    18. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    19. Loriano Mancini & Angelo Ranaldo & Jan Wrampelmeyer, 2013. "Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums," Journal of Finance, American Finance Association, vol. 68(5), pages 1805-1841, October.
    20. Coval, Joshua & Stafford, Erik, 2007. "Asset fire sales (and purchases) in equity markets," Journal of Financial Economics, Elsevier, vol. 86(2), pages 479-512, November.
    21. Dong Lou, 2012. "A Flow-Based Explanation for Return Predictability," The Review of Financial Studies, Society for Financial Studies, vol. 25(12), pages 3457-3489.
    22. Harold Demsetz, 1968. "The Cost of Transacting," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 82(1), pages 33-53.
    23. Phylaktis, Kate & Ravazzolo, Fabiola, 2005. "Stock prices and exchange rate dynamics," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1031-1053, November.
    24. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, vol. 74(1), pages 119-147, September.
    25. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2008. "Liquidity and market efficiency," Journal of Financial Economics, Elsevier, vol. 87(2), pages 249-268, February.
    26. Denis Gromb & Dimitri Vayanos, 2010. "A Model of Financial Market Liquidity Based on Intermediary Capital," Journal of the European Economic Association, MIT Press, vol. 8(2-3), pages 456-466, 04-05.
    27. Bartram, Söhnke M. & Bodnar, Gordon M., 2012. "Crossing the lines: The conditional relation between exchange rate exposure and stock returns in emerging and developed markets," Journal of International Money and Finance, Elsevier, vol. 31(4), pages 766-792.
    28. Allaudeen Hameed & Wenjin Kang & S. Viswanathan, 2010. "Stock Market Declines and Liquidity," Journal of Finance, American Finance Association, vol. 65(1), pages 257-293, February.
    29. Karolyi, G. Andrew & Lee, Kuan-Hui & van Dijk, Mathijs A., 2012. "Understanding commonality in liquidity around the world," Journal of Financial Economics, Elsevier, vol. 105(1), pages 82-112.
    30. Pesaran, H. Hashem & Shin, Yongcheol, 1998. "Generalized impulse response analysis in linear multivariate models," Economics Letters, Elsevier, vol. 58(1), pages 17-29, January.
    31. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2000. "Commonality in liquidity," Journal of Financial Economics, Elsevier, vol. 56(1), pages 3-28, April.
    32. Carpenter, Andrew & Wang, Jianxin, 2007. "Herding and the information content of trades in the Australian dollar market," Pacific-Basin Finance Journal, Elsevier, vol. 15(2), pages 173-194, April.
    33. Kee H. Chung & Xin Zhao, 2004. "Price And Quantity Quotes On Nasdaq: A Study Of Dealer Quotation Behavior," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 27(4), pages 497-519, December.
    34. Clifford S. Asness & Tobias J. Moskowitz & Lasse Heje Pedersen, 2013. "Value and Momentum Everywhere," Journal of Finance, American Finance Association, vol. 68(3), pages 929-985, June.
    35. Kamara, Avraham & Lou, Xiaoxia & Sadka, Ronnie, 2008. "The divergence of liquidity commonality in the cross-section of stocks," Journal of Financial Economics, Elsevier, vol. 89(3), pages 444-466, September.
    36. repec:oup:rfinst:v:25:y::i:12:p:3457-3489 is not listed on IDEAS
    37. Huberman, Gur & Halka, Dominika, 2001. "Systematic Liquidity," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(2), pages 161-178, Summer.
    38. Coughenour, Jay F. & Saad, Mohsen M., 2004. "Common market makers and commonality in liquidity," Journal of Financial Economics, Elsevier, vol. 73(1), pages 37-69, July.
    39. Tarun Chordia, 2005. "An Empirical Analysis of Stock and Bond Market Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 85-129.
    40. Lyons, Richard K., 1997. "A simultaneous trade model of the foreign exchange hot potato," Journal of International Economics, Elsevier, vol. 42(3-4), pages 275-298, May.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Chiara Banti, 2016. "Illiquidity In The Stock And Foreign Exchange Markets: An Investigation Of Their Cross-Market Dynamics," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 39(4), pages 411-436, December.
    2. Inekwe, John Nkwoma, 2020. "Liquidity connectedness and output synchronisation," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 66(C).
    3. Schneider, Michael & Lillo, Fabrizio & Pelizzon, Loriana, 2016. "How has sovereign bond market liquidity changed? An illiquidity spillover analysis," SAFE Working Paper Series 151, Leibniz Institute for Financial Research SAFE.
    4. Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1289-1361, Elsevier.
    5. Nina Karnaukh & Angelo Ranaldo & Paul Söderlind, 2015. "Understanding FX Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 28(11), pages 3073-3108.
    6. Anagnostidis, Panagiotis & Fontaine, Patrice, 2020. "Liquidity commonality and high frequency trading: Evidence from the French stock market," International Review of Financial Analysis, Elsevier, vol. 69(C).
    7. O’Sullivan, Conall & Papavassiliou, Vassilios G., 2020. "On the term structure of liquidity in the European sovereign bond market," Journal of Banking & Finance, Elsevier, vol. 114(C).
    8. Banti, Chiara & Phylaktis, Kate, 2015. "FX market liquidity, funding constraints and capital flows," Journal of International Money and Finance, Elsevier, vol. 56(C), pages 114-134.
    9. Chuliá, Helena & Koser, Christoph & Uribe, Jorge M., 2020. "Uncovering the time-varying relationship between commonality in liquidity and volatility," International Review of Financial Analysis, Elsevier, vol. 69(C).
    10. Chung, Kee H. & Chuwonganant, Chairat, 2014. "Uncertainty, market structure, and liquidity," Journal of Financial Economics, Elsevier, vol. 113(3), pages 476-499.
    11. Jiang, Lei, 2014. "Stock liquidity and the Taylor rule," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 202-214.
    12. Chang, Ya-Ting & Gau, Yin-Feng & Hsu, Chih-Chiang, 2017. "Liquidity Commonality in Foreign Exchange Markets During the Global Financial Crisis and the Sovereign Debt Crisis: Effects of Macroeconomic and Quantitative Easing Announcements," The North American Journal of Economics and Finance, Elsevier, vol. 42(C), pages 172-192.
    13. Moshirian, Fariborz & Qian, Xiaolin & Wee, Claudia Koon Ghee & Zhang, Bohui, 2017. "The determinants and pricing of liquidity commonality around the world," Journal of Financial Markets, Elsevier, vol. 33(C), pages 22-41.
    14. Suardi, Sandy & Xu, Caihong & Zhou, Z. Ivy, 2022. "COVID-19 pandemic and liquidity commonality," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 78(C).
    15. Lee, Jieun & Ryu, Doojin, 2019. "How does FX liquidity affect the relationship between foreign ownership and stock liquidity?," Emerging Markets Review, Elsevier, vol. 39(C), pages 101-119.
    16. Craig W. Holden & Stacey Jacobsen & Avanidhar Subrahmanyam, 2014. "The Empirical Analysis of Liquidity," Foundations and Trends(R) in Finance, now publishers, vol. 8(4), pages 263-365, December.
    17. Byomakesh Debata & Jitendra Mahakud, 2018. "Economic policy uncertainty and stock market liquidity," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 10(1), pages 112-135, April.
    18. Saad, Mohsen & Samet, Anis, 2020. "Collectivism and commonality in liquidity," Journal of Business Research, Elsevier, vol. 116(C), pages 137-162.
    19. Chiu, Yen-Chen, 2020. "Macroeconomic uncertainty, information competition, and liquidity," Finance Research Letters, Elsevier, vol. 34(C).
    20. Martin Hoesli & Anjeza Kadilli & Kustrim Reka, 2017. "Commonality in Liquidity and Real Estate Securities," The Journal of Real Estate Finance and Economics, Springer, vol. 55(1), pages 65-105, July.

    More about this item

    Keywords

    HG;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:esy:uefcwp:15626. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Nikolaos Vlastakis (email available below). General contact details of provider: https://edirc.repec.org/data/fcessuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.