HFTs and Dealer Banks: Liquidity and Price Discovery in FX Trading

48 Pages Posted: 8 Feb 2023 Last revised: 22 Jun 2023

See all articles by Wenqian Huang

Wenqian Huang

Bank for International Settlements

Peter O'Neill

UNSW Australia Business School, School of Banking and Finance

Angelo Ranaldo

University of St. Gallen; Swiss Finance Institute

Shihao Yu

Columbia University

Date Written: March 22, 2023

Abstract

In this paper, we characterise the liquidity provision and price discovery roles of dealers and HFTs in the FX spot market during the sample period between 2012 and 2015. We find that they have different responses to adverse market conditions: HFT liquidity provision is less sensitive to spikes in market-wide volatility, while dealer bank liquidity is more robust ahead of scheduled macroeconomic news announcements when adverse selection risk is high. In periods of extreme levels of volatility, such as the `Swiss De-peg' event in our sample, HFTs appear to withdraw almost all liquidity while dealers remain. In normal times, we also find that HFTs contribute to market liquidity by passively trading against the pricing errors created by dealers' aggressive trade flows. On price discovery, HFTs contribute the dominant share, mostly through their high-frequency quote updates which incorporate public information. In contrast, dealers contribute to price discovery more through trades that impound private information.

Keywords: HFT, Dealer Banks, Liquidity, Price Discovery, FX

JEL Classification: G14, G21

Suggested Citation

Huang, Wenqian and O'Neill, Peter and Ranaldo, Angelo and Yu, Shihao, HFTs and Dealer Banks: Liquidity and Price Discovery in FX Trading (March 22, 2023). FCA Occasional Paper 63, 2023, UNSW Business School Research Paper Forthcoming, Swiss Finance Institute Research Paper No. 23-48, Available at SSRN: https://ssrn.com/abstract=4349184 or http://dx.doi.org/10.2139/ssrn.4349184

Wenqian Huang

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://wenqianhuang.org

Peter O'Neill

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

HOME PAGE: http://peteroneill.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

Shihao Yu (Contact Author)

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

HOME PAGE: http://www.shihaoyu.org

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