Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/64828
Authors: 
Reitz, Stefan
Schmidt, Markus A.
Taylor, Mark P.
Year of Publication: 
2012
Series/Report no.: 
Kiel Working Paper 1794
Abstract: 
Though unambiguously outperforming all other financial markets in terms of liquidity, foreign exchange trading is still performed in opaque and decentralized markets. In particular, the two-tier market structure consisting of a customer segment and an interdealer segment to which only market makers have access gives rise to the possibility of price discrimination. We provide a theoretical foreign exchange pricing model that accounts for market power considerations and analyze a database of the trades of a German market maker and his cross section of end-user customers. We find that the market maker generally exerts low bargaining power vis-á-vis his customers. The dealer earns lower average spreads on trades with financial customers than commercial customers, even though the former are perceived to convey exchange-rate-relevant information. From this perspective, it appears that market makers provide interdealer market liquidity to end-user customers with cross-sectionally differing spreads.
Subjects: 
foreign exchange
market microstructure
pricing behavior
JEL: 
F31
Document Type: 
Working Paper

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