Foreign exchange market bid-ask spread and market power in an underdeveloped economy

Tarron Khemraj and Sukrishnalall Pasha

MPRA Paper from University Library of Munich, Germany

Abstract: This paper explores the influence of trader (or cambio) market power in determining the foreign exchange market bid-ask spread. In particular, it presents a theoretical model that incorporates the notion of oligopolistic power into the foreign exchange market. The econometric analysis substantiates the existence of oligopolistic trader market power in determining the spread. Moreover, the results confirm the prediction of standard market microstructure theory that volatility exerts a positive effect on spread. We also uncovered a positive relationship between liquidity (the quantity of foreign exchange traded) and spread, a result which differs from the existing literature. We interpret this finding to mean that oligopolistic traders set the mark-up exchange rate above where the purely competitive rate would have been so as to generate a surplus of US$ that is then hoarded. The econometric exercise utilizes a unique data set of trading volumes and buying/selling exchange rates for each cambio from January 2000 to December 2007.

Keywords: bid-ask spread; foreign exchange market; GLS (search for similar items in EconPapers)
JEL-codes: D43 F00 N16 O11 (search for similar items in EconPapers)
Date: 2008-10
New Economics Papers: this item is included in nep-com, nep-ifn and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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https://mpra.ub.uni-muenchen.de/30989/2/MPRA_paper_30989.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:11422

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