Liquidity in the Global Foreign Exchange Market

We study the global market liquidity of foreign exchange rates by analysing the price impact of trading. We propose a simple theoretical framework that refines the popular Amihud
(2002) illiquidity measure and term our new estimator realized Amihud. We highlight our measure’s consistency and higher accuracy, and these properties are validated numerically and empirically using CLS data representative of global FX trading. The price impact of FX
trading increases with transaction costs, money market stress, uncertainty, and risk aversion. Furthermore, currencies with smaller price impact are less prone to deviations from triangular
no-arbitrage parity. Our results are corroborated by an instrumental variables approach and a quasi-natural experiment using the shock of the Swiss franc’s uncapping in January 2015.