Dollar Dominance in FX Trading

72 Pages Posted: 2 Aug 2021 Last revised: 1 Nov 2022

See all articles by Fabricius Somogyi

Fabricius Somogyi

D’Amore-McKim School of Business

Date Written: August 1, 2022

Abstract

Over 85% of all foreign exchange transactions involve the dollar, whereas the United States accounts for a much smaller fraction of global economic activity. My paper attributes this dominance of the US dollar to the strategic avoidance of price impact. I derive three conditions for dollar dominance: Dollar pairs exhibit i) larger and ii) more volatile fundamental trading demands but iii) less volatile exchange rates than non-dollar pairs. I empirically test these conditions and provide evidence consistent with my theory. I show that 36-40% of the volume in dollar pairs arises from using the dollar as a vehicle currency to indirectly exchange two non-dollar currencies.

Keywords: Dollar dominance, foreign exchange volume, price impact, strategic complementarity

JEL Classification: F31, G12, G15

Suggested Citation

Somogyi, Fabricius, Dollar Dominance in FX Trading (August 1, 2022). Northeastern U. D’Amore-McKim School of Business Research Paper No., Available at SSRN: https://ssrn.com/abstract=3882546 or http://dx.doi.org/10.2139/ssrn.3882546

Fabricius Somogyi (Contact Author)

D’Amore-McKim School of Business ( email )

360 Huntington Ave.
Boston, MA 02115
United States

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