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.
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.
Liquidity Risk and Funding Cost Bechtel, Alexander; Ranaldo, Angelo; Wrampelmeyer, Jan
Review of Finance,
03/2023, Volume:
27, Issue:
2
Journal Article
Peer reviewed
Open access
Abstract
We propose and test a new channel that links liquidity risk and interest rates in short-term funding markets. Unlike existing theories that focus on premiums demanded by lenders, the ...liquidity risk channel postulates that borrowers that are more exposed to urgent liquidity needs are willing to pay a markup for immediate funding. We test and quantify the channel using unique trade-by-trade data and uncover systematic differences across individual banks’ funding cost driven by differences in banks’ liquidity risk. These differences are persistent over a decade, suggesting that the liquidity risk channel is relevant in general and not only arises during crisis times.
Unsecured and Secured Funding DI FILIPPO, MARIO; RANALDO, ANGELO; WRAMPELMEYER, JAN
Journal of money, credit and banking,
March-April 2022, Volume:
54, Issue:
2-3
Journal Article
Peer reviewed
Open access
We study how individual banks borrow and lend in the euro unsecured and secured interbank market. We find that banks with lower credit worthiness replace unsecured with secured borrowing, which is ...consistent with a reduction in the supply of unsecured loans rather than a lower demand for funding. Riskier lenders replace unsecured with secured lending, suggesting that banks take precautionary measures and prefer to lend against safe collateral. Our results highlight the importance of a joint analysis of unsecured and secured funding. Separate analyses only give a partial view and might yield misleading conclusions when banks access both funding sources.
This paper develops a liquidity measure tailored to the foreign exchange (FX) market, quantifies the amount of commonality in liquidity across exchange rates, and determines the extent of liquidity ...risk premiums embedded in FX returns. The new liquidity measure utilizes ultra high frequency data and captures cross-sectional and temporal variation in FX liquidity during the financial crisis of 2007-2008. Empirical results show that liquidity co-moves across currency pairs and that systematic FX liquidity decreases dramatically during the crisis. Extending an asset pricing model for FX returns by the novel liquidity risk factor suggests that liquidity risk is heavily priced.
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