Which Witch is Which? Deconstructing the FX Markets Activity

49 Pages Posted: 3 May 2023 Last revised: 20 Feb 2024

See all articles by Alexei G. Orlov

Alexei G. Orlov

Commodity Futures Trading Commission (CFTC)

Rajiv Sharma

U.S. Commodity Futures Trading Commission (CFTC)

Date Written: April 30, 2023

Abstract

Using regulatory data on transactions and positions, we provide a comprehensive overview of the activity in the foreign exchange (FX) derivatives markets, including futures, swaps, and options, covering both exchange-traded and over-the-counter (OTC) products. The heretofore publicly unavailable statistics trace the behavior of dealers, hedge funds, asset managers, pension funds, insurance companies, and sovereign and supranational institutions before, during, and in the aftermath of the market stress of March 2020. We show that when the COVID market shock sharply increased the demand for the U.S. dollar (USD), certain client sectors (e.g., hedge funds and sovereigns), along with dealers, provided USD liquidity by significantly increasing their long-USD swap positions. We find that client sectors are heterogeneous with respect to their liquidity needs and that their aggregate positions are small compared to dealer inventories. In addition to the inter-sector heterogeneity, we highlight the heterogeneity of firms within a client sector by focusing on hedge funds' USD/Euro swap positions—the most active client sector and currency pair in our data. The FX dealers, on the other hand, follow largely similar strategies, are competitive, and engage in multilateral netting arrangements to significantly reduce their risk exposure. Finally, using a sample of hedge funds that simultaneously participated in swaps and futures markets, we present evidence on trading volumes and frequencies that suggests that the OTC market is the preferred space for FX risk transfer, whereas the exchange-traded derivatives market serves the price discovery and immediacy functions for smaller trades.

Keywords: Foreign exchange markets, FX swaps, FX forwards, FX futures, FX options, FX spot markets, COVID market stress

JEL Classification: F31, G23, G10, G13, G15, G01

Suggested Citation

Orlov, Alexei G. and Sharma, Rajiv, Which Witch is Which? Deconstructing the FX Markets Activity (April 30, 2023). Available at SSRN: https://ssrn.com/abstract=4436692 or http://dx.doi.org/10.2139/ssrn.4436692

Alexei G. Orlov (Contact Author)

Commodity Futures Trading Commission (CFTC) ( email )

1155 21st Street NW
Washington, DC 20581
United States

Rajiv Sharma

U.S. Commodity Futures Trading Commission (CFTC) ( email )

1155 21st Street NW
Washington, DC 20581
United States

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