Price Formation in the Foreign Exchange Market

Florent Gallien, Sergei Glebkin, Serge Kassibrakis, Semyon Malamud, and Alberto Teguia

Working paper

This version: 28 August 2023

PDF

Abstract

We study joint price formation in the dealer-to-dealer (D2D) and dealer-to-customer (D2C) segments of the foreign exchange (FX) market, both theoretically and empirically. Our theory accounts for dealer heterogeneity, market power, and non-exclusive customer-dealer relationship and shows that several statistics of the cross-section of D2C quotes help predict D2D prices and liquidity. In particular, D2D prices are negatively related to cross-sectional covariance between D2C mid-quotes and spreads, contrary to predictions of other theories of two-tiered markets. Our predictions are confirmed empirically using unique proprietary D2C data. Model calibration reveals and quantifies the FX market’s inelasticity and non-competitiveness.

BibTeX

@unpublished{GallienGlebkinKassibrakisMalamudTeguia2023,
  author = {Gallien, Florent and Glebkin, Sergei and Kassibrakis, Serge and Malamud, Semyon and Teguia, Alberto},
  title = {Price Formation in the Foreign Exchange Market},
  year = {2023},
  note = {Working paper},
  url = {https://sglebkin.com/FX.pdf}
}