Constrained Liquidity Provision in Currency Markets

Wenqian Huang, Angelo Ranaldo, Andreas Schrimpf and Fabricius Somogyi
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Fabricius Somogyi: D’Amore-McKim School of Business

No 22-82, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We study dealers’ liquidity provision in the currency market. We show that at times when dealers’ intermediation capacity is constrained their cost of liquidity provision increases disproportionately relative to dealer-provided volume. As a result, the elasticity of dealers’ liquidity provision weakens by at least 80% relative to periods when they are unconstrained. We identify constrained periods based on leverage ratios, Value-at-Risk measures, credit default spreads, and debt funding costs. We interpret our novel empirical findings within a parsimonious model that sheds light on the key mechanisms of how liquidity provision by dealers tends to weaken when intermediary constraints are tightening.

Keywords: Currency markets; dealer constraints; market liquidity; foreign exchange; liquidity provision. (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Pages: 73 pages
Date: 2022-10
New Economics Papers: this item is included in nep-ban, nep-fmk, nep-ifn, nep-mon and nep-opm
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Constrained Liquidity Provision in Currency Markets (2024)
Working Paper: Constrained liquidity provision in currency markets (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2282

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