Constrained Liquidity Provision in Currency Markets

Wenqian Huang, Angelo Ranaldo, Andreas Schrimpf and Fabricius Somogyi

No 18776, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We devise a simple model of liquidity demand and supply to deepen the understanding of dealers’ liquidity provision in currency markets. Drawing on a globally representative data set on currency trading volumes, we show that at times when dealers' intermediation capacity is constrained the cost of liquidity provision increases disproportionately relative to dealer-intermediated volume. Thus, the otherwise strong and positive relation between liquidity costs and trading volume effectively shrinks to zero when dealers are more constrained. Using various econometric approaches, we show that this result primarily stems from a reduction in the elasticity of liquidity supply, rather than changes in liquidity demand.

Keywords: Currency markets; Liquidity provision; Market liquidity (search for similar items in EconPapers)
JEL-codes: F31 G12 G15 (search for similar items in EconPapers)
Date: 2024-01
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Related works:
Working Paper: Constrained liquidity provision in currency markets (2023)
Working Paper: Constrained Liquidity Provision in Currency Markets (2022)
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