Financial distress, dealers' behavior and asset pricing in the foreign exchange market

Exploiting a high frequency dealer-specific quote database in the FX market, I show that shocks to the CDS of a financial intermediary, proxy for its financial wealth, makes her quote larger bid-ask spreads when uncertainty about the underlying traded asset is high or when market competition is low. I first establish that markets are dominated by a handful of dealers who are responsible for more than 90% of the quotes in the different FX spot markets. I then document that, when exchange rate volatility is high, a 1% increase in intermediary's default probability does translate into a 4 bps increase in the bid-ask spread that she quotes. When competition is low, a similar deterioration in financial wealth leads to a 6.4 bps increase in bid-ask spread size. I finally show that in the case of emerging country currencies, the average CDS spread of the financial intermediaries quoting in the FX market is a statistically significant predictor for the volatility of the idiosyncratic component of the currency risk premium. More surprisingly, the dispersion in terms of financial wealth across financial intermediaries, measured as the variance of the financial intermediaries CDS spreads, is also an important determinant of this volatility for a large set of emerging country currencies.

Department dc:contributor.department

Sloan School of Management

Grantor dc:publisher

Massachusetts Institute of Technology

Year dc:date.issued

2018

Author dc:creator

• Fourel, Valère (Valère Renaud Ernst)

Advisor dc:contributor.advisor

• Adrien Verdelhan.

• Sloan School of Management.

Statement dc:rights

• MIT theses are protected by copyright. They may be viewed, downloaded, or printed from this source but further reproduction or distribution in any format is prohibited without written permission.

Licence dc:rights.uri

• http://dspace.mit.edu/handle/1721.1/7582

Language dc:language.iso

eng

Handle dc:identifier.uri

http://hdl.handle.net/1721.1/115654

OAI identifier oai:identifier

oai:dspace.mit.edu:1721.1/115654