Determinants of prices and spreads in global currency and money markets

Abstract

This thesis tackles two big questions. The first, from the macroeconomic literature is: what drives price?  The second, from the market microstructure literature, is: what determines the bid-ask spread?  The classification of these questions under these headings is conventional but is not strictly accurate. While macroeconomics has nothing to say about bid-ask spreads, market microstructure is concerned with price determination. Indeed, market microstructure views the two questions as so closely related that each is a linear function of the other in certain model settings.  This duality arises because every transaction price differs from the mid-quote price by the amount of the half-spread. Since the price sequence itself is made up of a series of price innovations, it follows that the average price innovation consists of a half-spread and of mid-quote revisions due to public news releases which are assumed random. However, this relationship does not tell us why bid-ask spreads arise in the first place nor does it fully describe why prices change. Two additional factors which move prices are inventory and asymmetric information. Inventory describes the (usually temporary) imbalances between supply and demand which give rise to the bid-ask spread as a management cost but which nonetheless require price innovations (concessions) to be absorbed. Asymmetric information about future price innovations not only contributes to the bid-ask spreads because of adverse selection risk, but it also drives price.  The remaining factor necessary to complete the picture of what determines prices and bid-ask spreads is termed ‘microstructure effects’.  These include price discreteness and price clustering.  It is a simple fact that prices are not continuous but instead move in discrete units and that some prices are used more frequently than others.  For the first time, this thesis reveals the percentage contribution of asymmetric information, inventory and of price clustering to bid-ask spreads in the order-driven inter-dealer spot FX and short term interest rate futures markets.  It also quantifies the respective contributions of news and inventory in shaping prices in these markets.  Independently, it proves that asymmetric information could not be the dominant driver of prices or of the bid-ask spreads, in both markets.  Finally, it shows that the level of asymmetric information in spot FX rates fell precipitously after EMU.

More information

Identifiers

Catalogue record

Export record

ASCII CitationAtomBibTeXData Cite XMLDublin CoreDublin CoreEP3 XMLEndNoteHTML CitationHTML CitationHTML ListJSONMETSMODSMPEG-21 DIDLOpenURL ContextObjectOpenURL ContextObject in SpanRDF+N-TriplesRDF+N3RDF+XMLRIOXX2 XMLReferReference ManagerSimple Metadata