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Financial intermediation and the role of price discrimination in the foreign exchange market

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  • Stefan Reitz
  • Markus A. Schmidt
  • Mark P. Taylor

Abstract

Foreign exchange trading is performed in opaque and decentralized markets. 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 develop a theoretical pricing model that accounts for market-power considerations and analyze a database of the trades of a foreign exchange market maker. We find that the market maker generally exerts low bargaining power vis-á-vis 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.

Suggested Citation

  • Stefan Reitz & Markus A. Schmidt & Mark P. Taylor, 2015. "Financial intermediation and the role of price discrimination in the foreign exchange market," The European Journal of Finance, Taylor & Francis Journals, vol. 21(8), pages 629-645, June.
    • Handle: RePEc:taf:eurjfi:v:21:y:2015:i:8:p:629-645
    DOI: 10.1080/1351847X.2013.830139
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