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Price Discovery in Currency Markets

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  • Carol Osler

    ()
    (International Business School, Brandeis University)

  • Alexander Mende

    (Leibniz Universität)

  • Lukas Menkhoff

    (Leibniz Universität)

Abstract

This paper examines the price discovery process in currency markets, basing its analysis on the pivotal distinction between the customer (end-user) market and the interdealer market. It first provides evidence that the price discovery process cannot be based on adverse selection between dealers and end users, as postulated in standard equity-market models, because the spreads dealers quote to their customers are not positively related to a trade’s likely information content. The paper then highlights three hypotheses from the literature – fixed operating costs, market power, and strategic dealing – that may explain the cross-sectional variation in customers spreads. The paper finishes by proposing a price discovery process relevant to liquid two-tier markets and providing preliminary evidence that this process applies to currencies.

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File URL: http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP03.pdf
File Function: First version, 2010
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Bibliographic Info

Paper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 03.

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Length: 44 pages
Date of creation: Jun 2010
Date of revision:
Handle: RePEc:brd:wpaper:03

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Postal: MS032, P.O. Box 9110, Waltham, MA 02454-9110
Web page: http://www.brandeis.edu/departments/economics/
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Related research

Keywords: Bid-ask spreads; foreign exchange; asymmetric information; microstructure; price discovery; interdealer; inventory; market order; limit order;

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References

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