Market Making in the Interbank Foreign Exchange Market
نویسنده
چکیده
This paper studies the market making behavior of FX dealers in the interbank market which is characterized by high trade volume and decentralized market structure. The dataset for my empirical estimation is based on the complete trade records of a FX dealer at a major commercial bank over 25 trading days. The dealer is among the five largest DM/$ dealers in the world, and the composition of his trades (customer trades, inter-dealer trades, etc.) is representative of the industry. I find evidence that incoming trades have information effects. However, I do not find evidence of price-shading as a tool for inventory control in inter-dealer trades. This is consistent with the view that quote shading signals a dealer’s position, and further reveals information from his proprietary order flows. A representative FX dealer instead lays off most undesired inventories through outgoing trades against other dealers’ quotes. Price impacts of such outgoing trades are minimized because the depth and low transparency of this market, together with the electronic dealing systems, allow a dealer to search effectively for the best prices. A dynamic analysis indicates that large trades have significant lagged price impacts, and that FX dealer often strategically delays quote revision to take advantage of low market transparency while working off inventory shocks. My study also suggests that dealers with diverse market positions might prefer different trading strategies. For example, an uninformed dealer with little customer business is likely to shade quotes for inventory control.
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