Market-maker, inventory control and foreign exchange dynamics

Frank Westerhoff

Quantitative Finance, 2003, vol. 3, issue 5, 363-369

Abstract: This paper examines how inventory management of foreign exchange dealers may affect exchange-rate dynamics. According to empirical observations, market makers set exchange rates not only with respect to excess demand but also in recognition of their inventory. Within our model, market makers control their positions by quoting exchange rates that provoke offsetting orders of technical and fundamental traders. Our model demonstrates that such behaviour may amplify trading volume, exchange-rate volatility and deviations from fundamentals.

Date: 2003
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DOI: 10.1088/1469-7688/3/5/302

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