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Theoretical perspective on euro liquidity

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Richard K. Lyons

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Abstract

I provide theoretical perspective on recent findings of increased transaction costs in the new dollar-euro market relative to the prior dollar-mark market, and assess the welfare significance of this drop in liquidity. In theory, transaction costs arise from information disadvantage costs, inventory management costs, and other market-making costs (e.g., order-processing costs). A review of theoretical reasons for the underlying costs to be rising can allow one to discriminate among hypotheses for the liquidity drop. New data on public trades support a customer liquidity hypothesis, based on the idea that the ultimate providers of liquidity in this market are customers rather than market-makers. However, the hypothesis is not consistent with the totality of the evidence, and I discuss how a combination of various mechanisms can influence transaction costs and the FX market's information efficiency. Copyright (c) CEPR, CES, MSH, 2002.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/1468-0327.00098
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Publisher Info
Article provided by CEPR, CES, MSH in its journal Economic Policy.

Volume (Year): 17 (2002)
Issue (Month): 35 (October)
Pages: 571-597
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Handle: RePEc:bla:ecpoli:v:17:y:2002:i:35:p:571-597

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  1. Michael J. Sager & Mark P. Taylor, 2006. "Under the microscope: the structure of the foreign exchange market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(1), pages 81-95. [Downloadable!]
  2. Reitz, Stefan & Schmidt, Markus & Taylor , Mark P., 2009. "Financial Intermediation and the Role of Price Discrimination in a Two-Tier Market," MPRA Paper 15602, University Library of Munich, Germany. [Downloadable!]
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