Asymmetric Information and the Foreign Exchange Trades of Global Custody Banks

Abstract:     
This paper provides the first rigorous empirical analysis of markups on custodial foreign exchange trades. It finds that they substantially exceed relevant benchmarks such as interbank half-spreads. We trace this to an information asymmetry: custodial bank dealers know more about their prices and bid-ask spreads than their client funds. We also examine the asset managers’ continued heavy reliance on this high-cost approach to trading when alternatives are available with lower markups. We provide evidence that this choice does not reflect ignorance of the cost differential. Analysis relies on the complete foreign exchange trading record of a mid-sized global custody bank during calendar year 2006.

Number of Pages in PDF File: 35

Keywords: Asymmetric Information, Currency Markets, Microstructure, Institutional Investment

JEL Classification: F31, G14, G15, G21

working papers series