Network Structure and Pricing in the FX Market
77 Pages Posted: 12 Feb 2020 Last revised: 9 Sep 2020
Date Written: January 17, 2020
For a foreign exchange settlement network we construct profit attributions and relate them to centrality. Our sample (from CLS Bank) spans diverse currency pairs, participants, and execution platforms. For each settlement we define the average centrality differential as the return to the more-central counterparty in the trade, and model this as a function of the two counterparties’ centralities. Estimates of this differential are generally positive, implying that the more-central counterparty realizes a higher return. Additionally, the differential generally increases as the counterparties’ centralities diverge. These two results are consistent with a pervasive centrality premium. The estimates are robust to the choice of pre- or post-settlement benchmarks, to inclusion of settlement size interactions, and to weighting the degree centralities by number or value of settlements. Across currency pairs the centrality profit varies considerably, and typically amounts to about one-third of bid-ask half-spread. The centrality premium is consistent with the hypothesis that central agents exercise bargaining power. We also find, however, evidence suggesting that the premium is at least partially offset by losses that central agents incur in supplying liquidity.
Keywords: foreign exchange, CLS Bank, centrality, settlement
JEL Classification: F31, G12, G15, G23
Suggested Citation: Suggested Citation