Constrained Liquidity Provision in Currency Markets

73 Pages Posted: 5 Nov 2021 Last revised: 2 Nov 2022

See all articles by Wenqian Huang

Wenqian Huang

Bank for International Settlements

Angelo Ranaldo

University of St. Gallen; Swiss Finance Institute

Andreas Schrimpf

CREATES - Aarhus University; Bank for International Settlements (BIS) - Monetary and Economic Department

Fabricius Somogyi

D’Amore-McKim School of Business

Date Written: November 4, 2021

Abstract

We study dealers’ liquidity provision in the currency market. We show that at times when dealers’ intermediation capacity is constrained their cost of liquidity provision increases disproportionately relative to dealer-provided volume. As a result, the elasticity of dealers’ liquidity provision weakens by at least 80% relative to periods when they are unconstrained. We identify constrained periods based on leverage ratios, Value-at-Risk measures, credit default spreads, and debt funding costs. We interpret our novel empirical findings within a parsimonious model that sheds light on the key mechanisms of how liquidity provision by dealers tends to weaken when intermediary constraints are tightening.

Keywords: Currency markets, dealer constraints, market liquidity, foreign exchange, liquidity provision.

JEL Classification: F31, G12, G15

Suggested Citation

Huang, Wenqian and Ranaldo, Angelo and Schrimpf, Andreas and Schrimpf, Andreas and Somogyi, Fabricius, Constrained Liquidity Provision in Currency Markets (November 4, 2021). University of St.Gallen, School of Finance Research Paper No. 2021/16 , Swiss Finance Institute Research Paper No. 22-82, Available at SSRN: https://ssrn.com/abstract=3956582. or http://dx.doi.org/10.2139/ssrn.3956582

Wenqian Huang (Contact Author)

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://wenqianhuang.org

Angelo Ranaldo

University of St. Gallen ( email )

School of Finance
Unterer Graben 21
St. Gallen, 9000
Switzerland
+41712247010 (Phone)

HOME PAGE: http://fin-sr.unisg.ch

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland
+41796637711 (Phone)

HOME PAGE: http://www.sfi.ch/de/about-us/news/hsg-faculty-members

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

CREATES - Aarhus University ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Fabricius Somogyi

D’Amore-McKim School of Business ( email )

360 Huntington Ave.
Boston, MA 02115
United States

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