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Price Formation in the Foreign Exchange Market

Author

Listed:
  • Florent Gallien

    (Swissquote)

  • Sergei Glebkin

    (INSEAD)

  • Serge Kassibrakis

    (Swissquote)

  • Semyon Malamud

    (Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute)

  • Alberto Teguia

    (UBC Sauder)

Abstract

We study joint price formation in the dealer-to-dealer (D2D) and dealer-to-customer (D2C) segments of the foreign exchange (FX) market, both theoretically and empirically. Our theory accounts for dealer heterogeneity, market power, and non-exclusive customer-dealer relationship and shows that several statistics of the cross-section of D2C quotes help predict D2D prices and liquidity. In particular, D2D prices are negatively related to cross-sectional covariance between D2C mid-quotes and spreads, contrary to predictions of other theories of two-tiered markets. Our predictions are confirmed empirically using unique proprietary D2C data. Model calibration reveals and quantifies the FX market’s inelasticity and non-competitiveness.

Suggested Citation

  • Florent Gallien & Sergei Glebkin & Serge Kassibrakis & Semyon Malamud & Alberto Teguia, 2023. "Price Formation in the Foreign Exchange Market," Swiss Finance Institute Research Paper Series 23-68, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2368
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    More about this item

    Keywords

    Liquidity; Foreign Exchange; OTC markets; Price Impact; Market Power;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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