Liquidity Risk and Currency Premia *
Journal
Management Science
ISSN
0025-1909
Type
journal article
Date Issued
2023-09-12
Author(s)
Abstract
The currency market is the world's largest financial market by trading volume. We show that even in this highly liquid market exposure to liquidity risk commands an economically significant risk premium of up to 3.6% per year. Liquidity risk is not subsumed by existing currency risk factors and successfully prices the cross-section of currency excess returns. Moreover, we find that liquidity risk and carry trade premia are correlated, although this correlation is limited to static rather than dynamic carry trades. Building upon this result, we propose a liquidity-based explanation for the carry trade, which adds significant explanatory power to existing theories.
Language
English
Keywords
Currency portfolios
carry trade returns
FX liquidity risk
liquidity risk premium
Refereed
Yes
Volume
forthcoming
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Name
Soderlind_Somogyi_2021_FxLiqAp_v12Sep2023_vSSRN.pdf
Size
5.19 MB
Format
Adobe PDF
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