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|Title:||Financial intermediation and the role of price discrimination in a two-tier market |
Schmidt, Markus A.
Taylor, Mark P.
|Issue Date:||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.|
|Document Type:||Working Paper|
|Appears in Collections:||Economists Online|
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