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Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums
Author(s) -
MANCINI LORIANO,
RANALDO ANGELO,
WRAMPELMEYER JAN
Publication year - 2013
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12053
Subject(s) - market liquidity , liquidity risk , liquidity premium , accounting liquidity , liquidity crisis , monetary economics , funding liquidity , business , equity (law) , market impact , carry (investment) , economics , market microstructure , order (exchange) , finance , law , political science
We provide the first systematic study of liquidity in the foreign exchange market. We find significant variation in liquidity across exchange rates, substantial illiquidity costs, and strong commonality in liquidity across currencies and with equity and bond markets. Analyzing the impact of liquidity risk on carry trades, we show that funding (investment) currencies offer insurance against (exposure to) liquidity risk. A liquidity risk factor has a strong impact on carry trade returns from 2007 to 2009, suggesting that liquidity risk is priced. We present evidence that liquidity spirals may trigger these findings.