Uninformed but Consequential: Corporate Trading in Over-the-counter FX Markets

59 Pages Posted: 29 Apr 2022 Last revised: 7 Feb 2023

See all articles by Umang Khetan

Umang Khetan

University of Iowa - Department of Finance

Petra Sinagl

University of Iowa - Department of Finance

Date Written: January 31, 2023

Abstract

We examine the role of multinational corporations in explaining the extraordinary volume and price volatility in foreign exchange (FX) markets. Corporations represent a distinct segment of discretionary traders with negatively correlated order flow to that of informed agents, which allows for internalization of dealers’ inventory. However, liquidity shocks experienced by them contribute to a “hot potato effect”: the repeated passing of dealers’ inventory imbalances. Using settlement breaks to instrument for quasi-exogenous shocks to liquidity-motivated trading, we find that a dollar increase in corporate volume leads to more than two dollars being exchanged in the inter- dealer segment. This hot potato effect exacerbates noise in currency prices, with a one standard deviation rise in corporate order imbalance leading to a 22% increase in return volatility. In contrast to other traders, spreads paid by corporations increase with volume, suggesting that dealers view large corporate flows as a source of inventory risk.

Keywords: Foreign Exchange, Market Microstructure, Information, Volatility

JEL Classification: F31, G12, G15

Suggested Citation

Khetan, Umang and Sinagl, Petra, Uninformed but Consequential: Corporate Trading in Over-the-counter FX Markets (January 31, 2023). Available at SSRN: https://ssrn.com/abstract=4090782 or http://dx.doi.org/10.2139/ssrn.4090782

Umang Khetan (Contact Author)

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States

Petra Sinagl

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States

HOME PAGE: http://andrlikova.com

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