Liquidity in the foreign exchange spot market shrinks by more than 80% during periods when dealers’ balance sheets are constrained by factors such as leverage ratios and funding costs, according to a new working paper from the Bank for International Settlements (BIS).
The paper analyses the impact of dealer balance sheet constraints on the “triangular relation” between FX spot rates – for instance, when exchanging euros for US dollars that are converted to Canadian dollars and then back to
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