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We use intraday high-frequency data to measure liquidity in the foreign exchange (FX) market, and measure the magnitude and direction of liquidity spillover across different exchange rates. Using the connectedness index proposed by Diebold and Yilmaz (2009, 2012, 2014) based on the generalized variance decomposition, we provide evidence that FX liquidity spillover is related to U.S. macroeconomic announcements and financial crises. Empirical results show that the amount of FX liquidity spillover increases when global financial uncertainty is larger. We document that the transmission of liquidity across FX markets is time-varying and is related to inventory risk, information asymmetry, the uncertainty of U.S. dollar index returns, global FX market volatility, and news surprises regarding U.S. interest rates.
Keywords: Liquidity; Spillover; Foreign exchange market.
JEL Classification: F31, G15, C22.