Label Segmentation & Low-Liquidity Traps in Legally Fungible Currency Markets

Abstract

Legal fungibility fixes fundamental value, but it need not integrate liquidity. This paper studies an OTC currency market in which two legally interchangeable sovereign currencies are convertible at par and without charge, yet trade under distinct market labels. Using high-frequency quote data, this paper shows that legal fungibility does not eliminate liquidity segmentation. The thinner label has persistently wider spreads and lower quote activity, while cross-label price differences rarely exceed the cost of cross-market execution. A one-sided settlement-infrastructure reform provides a stress test of whether this segmentation can be overturned. The reform generates limited changes in quoted conditions and modest evidence of greater short-run quote responsiveness, but no durable convergence in prices, spreads, or quote activity. The low-liquidity state remains frequent and persistent after the reform. The findings show that legal parity and improved infrastructure are insufficient to reverse an established concentration of liquidity. Legally fungible claims can therefore sustain persistent low-liquidity traps.