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.
We explain the currency carry trade (CT) performance using an asset pricing model in which factor loadings are regime dependent rather than constant. Empirical results show that a typical CT strategy ...has much higher exposure to the stock market and is mean reverting in regimes of high foreign exchange volatility. The findings are robust to various extensions. Our regime-dependent pricing model provides significantly smaller pricing errors than a traditional model. Thus, the CT performance is better explained by a time-varying systematic risk that increases in volatile markets, suggesting a partial resolution of the uncovered interest parity puzzle.
We propose a new method to estimate the bid-ask spread when quote data are not available. Compared to other low-frequency estimates, this method utilizes a wider information set, namely, readily ...available close, high, and low prices. In the absence of end-of-day quote data, this method generally provides the highest cross-sectional and average time-series correlations with the TAQ effective spread benchmark. Moreover, it delivers the most accurate estimates for less liquid stocks. Our estimator has many potential applications, including an accurate measurement of transaction cost, systematic liquidity risk, and commonality in liquidity for U.S. stocks dating back almost one century.
This work studies the information content of trades in the world’s largest over-the-counter (OTC) market, the foreign exchange (FX) market. It analyzes a novel, comprehensive order flow data set, ...distinguishing among different groups of market participants and covering a large cross-section of currency pairs. We find compelling evidence of heterogeneous superior information across agents, time, and currency pairs, consistent with the asymmetric information theory and OTC market fragmentation. A trading strategy based on the permanent price impact, capturing asymmetric information risk, generates high returns even after accounting for risk, transaction cost, and other common risk factors shown in the FX literature.
Taking advantage of a trades-and-quotes high-frequency database, we document the main stylized facts and dynamic properties of spot precious metals, i.e. gold, silver, palladium and platinum. We ...analyse the behaviours of spot prices, returns, volume and selected liquidity measures. We find clear evidence of periodic patterns matching the trading hours of the most active markets round-the-clock. The time series of spot returns have, thus, properties similar to those of traditional financial assets with fat tails, asymmetry, periodic behaviours in the conditional variances and volatility clustering. Gold (platinum) is the most (least) liquid and least (most) volatile asset. Commonality in liquidities of precious metals is very strong.
Liquidity in the global currency market Ranaldo, Angelo; de Magistris, Paolo Santucci
Journal of financial economics,
December 2022, 2022-12-00, Volume:
146, Issue:
3
Journal Article
Peer reviewed
Open access
We study the liquidity of the global currency market by analyzing the price impact of trading volume. We analyze a decade of CLS intraday data representative of global foreign exchange (FX) trading ...by developing a refinement of the popular Amihud (2002) illiquidity measure that we call realized Amihud, which is the ratio between realized volatility and trading volume. Inversely related to market depth, price impact increases with transaction costs, money market stress, uncertainty, and risk aversion. Furthermore, we analyze whether and how liquidity begets price efficiency by looking at violations of the “triangular” no-arbitrage condition. We find that dollar-based currencies offer a lower trading impact supporting price efficiency.
Using unique data at transaction and identity levels, we provide the first systematic study of interest rate swaps traded over the counter (OTC). We find substantial and persistent heterogeneity in ...derivative prices consistent with a pass-through of regulatory costs on to market prices via so-called valuation adjustments (XVA). A client pays a higher price to buy interest rate protection from a dealer (i.e., the client pays a higher fixed rate) if the contract is not cleared via a central counterparty. This OTC premium decreases by posting initial margins and with higher buyer’s creditworthiness. OTC premia are absent for dealers suggesting bargaining power.
Abstract
A repurchase agreement (repo) is a source of cash and collateral. We document that the money market is more segmented when the collateral motive prevails. Two crucial aspects of the central ...bank framework lead to this disconnect: banks’ access to the central bank’s deposit facility and assets’ eligibility for quantitative easing (QE). We show that repo rates lent by banks with access to the deposit facility and secured by QE eligible assets are more collateral-driven and disconnected from funding-based money market rates. Our results are relevant for different monetary policies and have suggestive implications for the monetary policy pass-through.
Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.
The Euro Interbank Repo Market Mancini, Loriano; Ranaldo, Angelo; Wrampelmeyer, Jan
The Review of financial studies,
07/2016, Volume:
29, Issue:
7
Journal Article
Peer reviewed
The search for a market design that ensures stable bank funding is at the top of regulators' policy agenda. This paper empirically shows that the central counterparty (CCP)-based euro interbank repo ...market features this stability. Using a unique and comprehensive data set, we show that the market is resilient during crisis episodes and may even act as a shock absorber, in the sense that repo lending increases with risk, while spreads, maturities, and haircuts remain stable. Our comparison across different repo markets shows that anonymous CCP-based trading, safe collateral, and the absence of an unwind mechanism are the key characteristics to ensure market resilience.
Regulatory effects on short-term interest rates Ranaldo, Angelo; Schaffner, Patrick; Vasios, Michalis
Journal of financial economics,
August 2021, 2021-08-00, 20210801, Volume:
141, Issue:
2
Journal Article
Peer reviewed
Open access
We analyze the effects of prudential regulation on short-term interest rates. The European Market Infrastructure Regulation (EMIR) induces clearing houses (CCPs) to supply large amounts of cash in ...reverse repurchase agreements (repos). Basel III, in contrast, disincentivizes the borrowing demand by tightening banks’ balance sheet constraints. Using unique regulatory data of CCP investment activity and repo transactions, we find compelling evidence for both the supply and demand channels. The overall effects are decreasing short-term rates and increasing market imbalances in various forms, all of which entail unintended consequences due to the new regulatory framework.
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