SIFR Research Report Series, Institute for Financial Research
Geir Hoidal Bjonnes
Dealer Behavior and Trading Systems in Foreign Exchange Markets
() and Dagfinn Rime
Abstract: We study dealer behavior in the foreign exchange spot
market using a detailed data set on the complete transactions of four
dealers. There is strong support for an information effect in incoming
trades. Although there is evidence that the information effect increases
with trade size in direct bilateral trades, the direction of a trade seems
to be more important. The large share of electronically brokered trades is
probably responsible for this finding. In direct trades it is the
initiating dealer that determines trade size, while in broker trades it is
the dealer submitting the limit order that determines the maximum trade
size. We also find strong evidence of inventory control for all the four
dealers. Inventory control is not, however, manifested through a dealer's
own prices as suggested in inventory models. This is different from the
strong price effect from inventory control found in previous work by Lyons
[J. Fin. Econ 39(1995) 321]. A possible explanation for this finding is
that the introduction of electronic brokers allowed more trading options.
Furthermore, we document differences in trading styles among the four
dealers, especially how they actually control their inventories.
Keywords: Foreign Exchange; Trading; Microstructure; (follow links to similar papers)
JEL-Codes: F31; F33; G15; (follow links to similar papers)
31 pages, November 12, 2003
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- This paper is forthcoming as:
Hoidal Bjonnes, Geir and Dagfinn Rime, 'Dealer Behavior and Trading Systems in Foreign Exchange Markets', Journal of Financial Economics.
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