Constrained liquidity provision in currency markets

Wenqian Huang, Angelo Ranaldo, Andreas Schrimpf and Fabricius Somogyi

No 1073, BIS Working Papers from Bank for International Settlements

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 drops 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)
Date: 2023-02
New Economics Papers: this item is included in nep-ban, nep-fmk, nep-ifn and nep-mon
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Related works:
Working Paper: Constrained Liquidity Provision in Currency Markets (2024)
Working Paper: Constrained Liquidity Provision in Currency Markets (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:1073

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