Liquidity Provision in the Foreign Exchange Market

Florent Gallien, Serge Kassibrakis, Nataliya Klimenko, Semyon Malamud and Alberto Teguia
Additional contact information
Florent Gallien: Swissquote Bank
Serge Kassibrakis: Swissquote Bank
Nataliya Klimenko: University of Zurich
Semyon Malamud: Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute
Alberto Teguia: Rice University

No 18-56, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Foreign exchange operates as a two-tiered over-the-counter (OTC) market dominated by large, strategic dealers. Using proprietary high frequency data on quotes by the largest foreign exchange dealer banks in the Dealer-to-Client market, we nd a signi cant heterogeneity in their behavior. We develop a model of strategic competition that accounts for this heterogeneity and the two-tier market structure and allows us to link prices and bid-ask spreads in the D2C and D2D market segments. We use the model to recover dealers' risk aversions and inventories from their quotes in the D2C segment and construct an endogenous measure of systemic, non-diversi able risk capturing the cross-sectional liquidity-risk mismatch. Consistent with the model predictions, we nd that liquidity mismatch negatively predicts prices in the D2D market, while the cross-sectional dispersion in dealer risk aversions negatively predicts spreads in the D2D market.

Keywords: Liquidity; Foreign Exchange; OTC markets; Price Impact; Market Power (search for similar items in EconPapers)
JEL-codes: F31 G12 G14 G21 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2018-08, Revised 2018-08
New Economics Papers: this item is included in nep-mst
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1856

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