Just Another Day in the Inter-Bank Foreign Exchange Market
Posted: 16 Mar 2001
In this paper, I develop a theory of bid-ask quotes provided by foreign exchange dealers in the inter-bank market based on their beliefs and their inventory positions. I then build an agent-based model of the inter-dealer market where dealers learn in a Bayesian manner from quotes from other dealers. Using simulations, I find that the resulting intra-day spreads and between-quote returns largely conform to the empirically observed intra-day U-shaped pattern - a feature that has not been satisfactorily explained in the literature. I also study the factors that determine this U-shape.
Keywords: Agent based model, foreign exchange, microstructure
JEL Classification: D83, F31
Suggested Citation: Suggested Citation