What is the Impact of Introducing a Parallel OTC Market? Theory and Evidence from the Chinese Interbank FX Market
43 Pages Posted: 29 Aug 2020 Last revised: 9 Mar 2021
Date Written: March 9, 2021
Chinese Interbank Foreign Exchange trading was originally conducted through a centralized, anonymous limit order book (LOB). We determine the impact of the introduction of a parallel decentralized over-the-counter (OTC) market. We find that: (1) most trading migrated to the OTC, (2) the LOB price function is upward-sloping versus the OTC price function is downward-sloping, and (3) the LOB market has a single price function versus the OTC market has multiple price functions. Next, we develop a theoretical model of parallel markets that can simultaneously explain all of these empirical findings. We test a new model prediction and find support.
Keywords: Market structure, Over The Counter, Limit Order Book, FX market
JEL Classification: D83, G10
Suggested Citation: Suggested Citation