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Financial intermediation and the role of price discrimination in a two-tier market

Stefan Reitz, Markus A. Schmidt and Mark Taylor

No 1794, Kiel Working Papers from Kiel Institute for the World Economy (IfW Kiel)

Abstract: Though unambiguously outperforming all other financial markets in terms of liquidity, foreign exchange trading is still performed in opaque and decentralized markets. In particular, the two-tier market structure consisting of a customer segment and an interdealer segment to which only market makers have access gives rise to the possibility of price discrimination. We provide a theoretical foreign exchange pricing model that accounts for market power considerations and analyze a database of the trades of a German market maker and his cross section of end-user customers. We find that the market maker generally exerts low bargaining power vis-á-vis his customers. The dealer earns lower average spreads on trades with financial customers than commercial customers, even though the former are perceived to convey exchange-rate-relevant information. From this perspective, it appears that market makers provide interdealer market liquidity to end-user customers with cross-sectionally differing spreads.

Keywords: foreign exchange; market microstructure; pricing behavior (search for similar items in EconPapers)
JEL-codes: F31 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Financial Intermediation and the Role of Price Discrimination in a Two-Tier Market (2009) Downloads
Working Paper: Financial intermediation and the role of price discrimination in a two-tier market (2009) Downloads
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