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Which witch is which? Deconstructing the foreign exchange markets activity

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  • Orlov, Alexei G.
  • Sharma, Rajiv

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 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 US 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. Conversely, the FX dealers follow 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.

Suggested Citation

  • Orlov, Alexei G. & Sharma, Rajiv, 2024. "Which witch is which? Deconstructing the foreign exchange markets activity," Global Finance Journal, Elsevier, vol. 60(C).
    • Handle: RePEc:eee:glofin:v:60:y:2024:i:c:s104402832400019x
    DOI: 10.1016/j.gfj.2024.100947
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    References listed on IDEAS

    as
    1. Mathias Drehmann & Vladyslav Sushko, 2022. "The global foreign exchange market in a higher-volatility environment," BIS Quarterly Review, Bank for International Settlements, December.
    2. Torsten Ehlers & Bryan Hardy, 2019. "The evolution of OTC interest rate derivatives markets," BIS Quarterly Review, Bank for International Settlements, December.
    3. Viswanathan, S. & Wang, James J. D., 2002. "Market architecture: limit-order books versus dealership markets," Journal of Financial Markets, Elsevier, vol. 5(2), pages 127-167, April.
    4. Claudio Borio & Robert N McCauley & Patrick McGuire, 2022. "Dollar debt in FX swaps and forwards: huge, missing and growing," BIS Quarterly Review, Bank for International Settlements, December.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Foreign exchange markets; FX swaps; FX forwards; FX futures; FX options; FX spot markets; COVID market stress;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G01 - Financial Economics - - General - - - Financial Crises

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