Liquidity in the Foreign Exchange Market:Measurement, Commonality, and Risk Premiums

This paper develops a liquidity measure tailored to the foreign exchange (FX) market, quanties the amount of commonality in liquidity across dierent exchange rates, and determines theextent of liquidity risk premiums embedded in FX returns. The new liquidity measure utilizesultra high frequency data and captures cross-sectional and temporal variation in FX liquidityduring the nancial crisis of 2007{2008. As sudden shocks to market-wide liquidity have importantimplications for regulators and investors, liquidity is decomposed into an idiosyncratic anda common component.[...]

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Year of publication:	2009-11-19
Authors:	Mancini, Loriano ; Ranaldo, Angelo ; Wrampelmeyer, Jan
Institutions:	National Centre of Competence in ResearchFinancial Valuation and Risk Management
Subject:	Liquidität \| Risikoprämie \| Devisenmarkt \| Messung \| Measurement

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1. Introduction
1.1. Related Literature
2. Liquidity Measures
2.1. Return Reversal
2.2. Estimation
2.3. Alternative Measures of Liquidity
3. Liquidity in Foreign Exchange Markets
3.1. The Data Set
3.2. Foreign Exchange Liquidity
4. Commonality in Foreign Exchange Liquidity
4.1. Averaging Liquidity Across Currencies
4.2. Latent Liquidity
4.3. Relation to Liquidity of the US Equity Market
5. Liquidity Risk Premiums
5.1. Monthly data
5.2. Risk Factors for Foreign Exchange Returns
5.3. Cross-sectional Asset Pricing and Market Prices of Risk
6. Robustness Analysis
6.1. Robustness of the Return Reversal Liquidity Measure
6.2. Robustness of Commonality in FX Liquidity
6.3. Robustness of Liquidity Risk Premiums
7. Conclusion
References

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