Foreign exchange market bid-ask spread and market power in an underdeveloped economy
AbstractThis paper explores the influence of trader (or cambio) market power in determining the foreign exchange market bid-ask spread. In particular, it presents a theoretical model that incorporates the notion of oligopolistic power into the foreign exchange market. The econometric analysis substantiates the existence of oligopolistic trader market power in determining the spread. Moreover, the results confirm the prediction of standard market microstructure theory that volatility exerts a positive effect on spread. We also uncovered a positive relationship between liquidity (the quantity of foreign exchange traded) and spread, a result which differs from the existing literature. We interpret this finding to mean that oligopolistic traders set the mark-up exchange rate above where the purely competitive rate would have been so as to generate a surplus of US$ that is then hoarded. The econometric exercise utilizes a unique data set of trading volumes and buying/selling exchange rates for each cambio from January 2000 to December 2007.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 11422.
Date of creation: Oct 2008
Date of revision:
bid-ask spread; foreign exchange market; GLS;
Find related papers by JEL classification:
- O11 - Economic Development, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
- F00 - International Economics - - General - - - General
- N16 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - Latin America; Caribbean
- D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-11-11 (All new papers)
- NEP-COM-2008-11-11 (Industrial Competition)
- NEP-IFN-2008-11-11 (International Finance)
- NEP-MST-2008-11-11 (Market Microstructure)
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