Price discovery in currency markets |
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Authors: | Carol L Osler Alexander Mende Lukas Menkhoff |
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Institution: | aBrandeis University, 415 South Street, Waltham, MA 02454, USA;bRPM Risk & Portfolio Management AB, Stockholm, Sweden;cLeibniz Universität Hannover, Königsworther Platz 1, D-30167 Hannover, Germany |
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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 this price discovery process cannot be based on adverse selection between dealers and their customers, as postulated in standard 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 factors familiar in 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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Keywords: | JEL classification: F31 G14 G15 |
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