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Exchange Rates and Liquidity Risk

Author

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  • Evans, Martin

Abstract

I use Forex trading data to study how risks associated with the lack of liquidity contribute to the dynamics of 17 spot exchange rates through their time-varying contributions to risk premia. I find that liquidity risk matters. All the foreign exchange risk premia compensate investors for exposure to liquidity risk; and, for many currencies, exposure to liquidity risk appears to be more important than exposure to the traditional carry and momentum risk factors. I also find that variations in the price of liquidity risk make economically important contributions to the behavior of individual foreign currency returns: they account for approximately 34 percent, on average, of the variability in currency returns compared to the contribution of approximately 8 percent from the prices of carry and momentum risk.

Suggested Citation

  • Evans, Martin, 2020. "Exchange Rates and Liquidity Risk," MPRA Paper 102702, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:102702
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    References listed on IDEAS

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    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • G1 - Financial Economics - - General Financial Markets

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