HFTs and Dealer Banks: Liquidity and Price Discovery in FX Trading

Wenqian Huang, Peter O'Neill, Angelo Ranaldo and Shihao Yu
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Peter O'Neill: University of New South Wales
Shihao Yu: Columbia University

No 23-48, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: In this paper, we characterise the liquidity provision and price discovery roles of dealers and HFTs in the FX spot market during the sample period between 2012 and 2015. We find that they have different responses to adverse market conditions: HFT liquidity provision is less sensitive to spikes in market-wide volatility, while dealer bank liquidity is more robust ahead of scheduled macroeconomic news announcements when adverse selection risk is high. In periods of extreme levels of volatility, such as the `Swiss De-peg' event in our sample, HFTs appear to withdraw almost all liquidity while dealers remain. In normal times, we also find that HFTs contribute to market liquidity by passively trading against the pricing errors created by dealers' aggressive trade flows. On price discovery, HFTs contribute the dominant share, mostly through their high-frequency quote updates which incorporate public information. In contrast, dealers contribute to price discovery more through trades that impound private information.

Keywords: HFT; Dealer Banks; Liquidity; Price Discovery; FX (search for similar items in EconPapers)
JEL-codes: G14 G21 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2023-06
New Economics Papers: this item is included in nep-mst
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2348

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