Khemraj, Tarron and Pasha, Sukrishnalall (2008): Foreign exchange market bid-ask spread and market power in an underdeveloped economy.
Download (110Kb) | Preview
This paper explores the influence of trader (or cambio) market power in determining the foreign exchange market bid-ask spread. In particular, it presents a theoretical model that incorporates the notion of oligopolistic power into the foreign exchange market. The econometric analysis substantiates the existence of oligopolistic trader market power in determining the spread. Moreover, the results confirm the prediction of standard market microstructure theory that volatility exerts a positive effect on spread. We also uncovered a positive relationship between liquidity (the quantity of foreign exchange traded) and spread, a result which differs from the existing literature. We interpret this finding to mean that oligopolistic traders set the mark-up exchange rate above where the purely competitive rate would have been so as to generate a surplus of US$ that is then hoarded. The econometric exercise utilizes a unique data set of trading volumes and buying/selling exchange rates for each cambio from January 2000 to December 2007.
|Item Type:||MPRA Paper|
|Original Title:||Foreign exchange market bid-ask spread and market power in an underdeveloped economy|
|Keywords:||bid-ask spread, foreign exchange market, GLS|
|Subjects:||O - Economic Development, Technological Change, and Growth > O1 - Economic Development > O11 - Macroeconomic Analyses of Economic Development
F - International Economics > F0 - General > F00 - General
N - Economic History > N1 - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations > N16 - Latin America; Caribbean
D - Microeconomics > D4 - Market Structure and Pricing > D43 - Oligopoly and Other Forms of Market Imperfection
|Depositing User:||Tarron Khemraj|
|Date Deposited:||08. Nov 2008 15:10|
|Last Modified:||12. Feb 2013 20:46|
Amihud, Y. and Mendelson, H. (1986) Asset pricing and the bid-ask spread, Journal of Financial Economics, 7, 223-249.
Becker, T. and Sy, A. (2006) Were bid-ask spreads in the FX market excessive during the Asian crisis? International Review of Financial Analysis, 15, 434-449.
Bollerslev, T. and Melvin, M. (1994) Bid-ask spreads and volatility in the foreign exchange market: an empirical analysis, Journal of International Economics, 36, 355-372.
Boothe, P. (1988) Exchange rate risk and the bid-ask spread: a seven country comparison, Economic Enquiry, 26, 485-492.
Brennan, M. and Subrahmanyam, A. (1996) Market microstructure and asset pricing, Journal of Financial Economics, 41, 441-464.
Das, U. and Ganga, G. (1997) A retrospect and prospect on the reform of the financial sector in Guyana, Social and Economic Studies, 46, 93-129.
Datar, V., Narayan, N. and Radcliffe, R. (1998) Liquidity and stock returns: an alternative test, Journal of Financial Markets, 1, 203-219.
Davidson, R. and MacKinnon, J. (2004) Econometric Theory and Methods, Oxford University Press, New York.
Egoume-Bossogo, P., Faal, E., Nallari, R., and Weisman, E. (2003) Guyana: Experience with Macroeconomic Stabilisation, Structural Adjustment, and Poverty Reduction, International Monetary Fund, Washington DC.
Galati, G. (2000) Trading volumes, volatility and spreads in foreign exchange markets: evidence from emerging market countries, BIS Working Paper No. 93 (October), Bank for International Settlements.
Galbis, V. (1993) Experience with floating interbank exchange rate systems in five developing countries, IMF Working Paper 93/36, International Monetary Fund.
Glassman, D. (1987) Exchange rate risks and transaction costs: evidence from bid-ask spreads, Journal of International Money and Finance, 6, 479-490.
Greene, W. (2003) Econometric Analysis (5th edition), Upper Saddle River, NJ, Prentice Hall.
Khemraj, T. (2008a) Excess liquidity and the foreign currency constraint: the case of monetary management in Guyana, Applied Economics, Vol. 40, iFirst.
Khemraj, T. (2008b) Excess liquidity, oligopolistic loan markets and monetary policy in LDCs, DESA Working Paper No. 64, United Nations.
Litzenberger, R. and Ramaswamy, K. (1980) Tax-induced investor clienteles and market equilibrium, The Journal of Finance, 35, 469-482.
Litzenberger, R. and Ramaswamy, K. (1979) The effects of personal taxes and dividends on capital asset prices, Journal of Financial Economics, 7, 163-195.
Melvin, M. and Tan, K. (1996) Foreign exchange market bid-ask spreads and the market price of social unrest, Oxford Economic Papers, 48, 329-341.
Mende, A. (2006) 09/11 on USD/EUR foreign exchange market, Applied Financial Economics, 6, 213-222.
Sarno, L. and Taylor, M. (2001) The microstructure of the foreign exchange market: a selective survey of the literature, Princeton Studies in International Economics, 89 (May).
Thomas, C. and Rampersaud, R. (1991) The cambio system of an independent exchange rate float: the case of Guyana, Social and Economic Studies, 40, 115-147.
White, H. (1980) A heteroskedastic-consistent covariance matrix and a direct test of heteroskedasticity, Econometrica, 48, 817-838.
Wooldridge, J. (2002). Econometric Analysis of Cross Section and Panel Data, MIT Press, Cambridge, MA.
Available Versions of this Item
- Foreign exchange market bid-ask spread and market power in an underdeveloped economy. (deposited 08. Nov 2008 15:10) [Currently Displayed]