Essays in FX market microstructure

The thesis presents three papers in the field of international finance and provides a study of the foreign exchange (FX) market from a microstructure perspective. From the empirical identification of a common component in liquidity across currencies, referred to as FX market liquidity, the thesis investigates its asset pricing implications, determinants and cross-market dynamics. The first paper is an empirical study of global liquidity risk in the FX market. Estimating liquidity with the Pastor-Stambaugh measure originally developed for the stock market, the paper documents strong liquidity commonality across currencies. Given this observation, it estimates a measure of global FX liquidity risk and shows that the risk is priced in the cross-section of currency returns. It finally evaluates the associated risk premium at around 4.7 percent per annum. The second paper provides an empirical analysis of the determinants of the time variation in FX market liquidity documented in the first paper. Employing two measures of liquidity, transaction costs and the Pastor-Stambaugh measure from the first paper, the study finds a significant role of traditional determinants, such as global volatility, market returns and seasonality, and of funding liquidity constraints to explain both aspects of market liquidity. Finally, the third paper is an empirical investigation of illiquidity linkages across the FX and US stock markets. Focusing on transaction costs, the paper finds strong evidence of co-movement, especially during the recent financial crisis. In this respect, illiquidity contagion across the two markets is documented. Given dealers' role as liquidity providers in both markets, their trading behaviour may have significant implications for cross-market liquidity dynamics. Indeed, focusing on the potential sources of the observed cross-market linkages, transaction costs are found to be strongly related to the liquidity supplied to the financial system.

Name dc:type.qualificationname

phd

Level dc:type.qualificationlevel

doctoral

Grantor dc:publisher.institution

City University London

Year dc:date.issued

2013

Author dc:creator

• Banti, Chiara

• HG Finance