Price Formation in the Foreign Exchange Market

Florent Gallien, Sergei Glebkin, Serge Kassibrakis, Semyon Malamud and Alberto Teguia
Additional contact information
Florent Gallien: Swissquote
Sergei Glebkin: INSEAD
Serge Kassibrakis: Swissquote
Semyon Malamud: Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute
Alberto Teguia: UBC Sauder

No 23-68, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We study joint price formation in the dealer-to-dealer (D2D) and dealer-to-customer (D2C) segments of the foreign exchange (FX) market, both theoretically and empirically. Our theory accounts for dealer heterogeneity, market power, and non-exclusive customer-dealer relationship and shows that several statistics of the cross-section of D2C quotes help predict D2D prices and liquidity. In particular, D2D prices are negatively related to cross-sectional covariance between D2C mid-quotes and spreads, contrary to predictions of other theories of two-tiered markets. Our predictions are confirmed empirically using unique proprietary D2C data. Model calibration reveals and quantifies the FX market’s inelasticity and non-competitiveness.

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: 111 pages
Date: 2023-08
New Economics Papers: this item is included in nep-ifn, nep-mon and nep-mst
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2368

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