Understanding FX Liquidity

Nina Karnaukh, Angelo Ranaldo, Paul Söderlind

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    We provide a comprehensive study of the liquidity of spot foreign exchange (FX) rates over more than two decades and a large cross-section of currencies. First, we show that FX liquidity can be accurately measured with daily and readily available data. Second, we demonstrate that FX liquidity declines with funding constraints and global risk, supporting theoretical models relating funding and market liquidity. In these distressed circumstances, liquidity tends to evaporate more for developed and riskier currencies. Finally, we show stronger comovements of FX liquidities in distressed markets, especially when funding is constrained, volatility is high, and FX speculators incur losses.

    Original languageEnglish
    JournalReview of Financial Studies
    Issue number11
    Pages (from-to)3073-3108
    Number of pages36
    Publication statusPublished - 2015

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