Market Making in Foreign Exchange Markets: Implications of Information Asymmetry
Koivisto, Janne (2012)
Koivisto, Janne
2012
Kuvaus
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Tiivistelmä
The study considers the effect of asymmetric information on price discovery process in foreign exchange markets. Under this approach, some agents in the market space are assumed to be better informed about foreign exchange fundamentals than others. This assumption is an important aspect of the microstructure approach to exchange rates, which underlines the heterogeneities among the trading population.
Market makers play an essential role in foreign exchange transactions, and as price setters, are a logical starting point for an exploration of possible existence of private information. The market making dealer is especially vulnerable in trading with market participants with superior knowledge of exchange rate fundamentals. Given this, one way to protect against losses to the informed ones is to widen the bid-ask spread at the time of a greater probability of facing an informed trader.
This study focuses solely on the interbank side of foreign exchange market. The distinction between customer market and interbank market makes it possible for strong players to take informational advantage from garnered order flow information. Using intraday Swedish krona/U.S. dollar exchange rate data, this study examines the behavior of bid- and ask-quotations surrounding 41 selected information releases. Supportive evidence for possible existence of informational advantages in foreign exchange market was found. These findings go along with previous studies examining asymmetric information across financial markets.
Market makers play an essential role in foreign exchange transactions, and as price setters, are a logical starting point for an exploration of possible existence of private information. The market making dealer is especially vulnerable in trading with market participants with superior knowledge of exchange rate fundamentals. Given this, one way to protect against losses to the informed ones is to widen the bid-ask spread at the time of a greater probability of facing an informed trader.
This study focuses solely on the interbank side of foreign exchange market. The distinction between customer market and interbank market makes it possible for strong players to take informational advantage from garnered order flow information. Using intraday Swedish krona/U.S. dollar exchange rate data, this study examines the behavior of bid- and ask-quotations surrounding 41 selected information releases. Supportive evidence for possible existence of informational advantages in foreign exchange market was found. These findings go along with previous studies examining asymmetric information across financial markets.