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Inferring Intermediary Risk Exposure from Trade

Author

Listed:
  • Chris Anderson

    (Division of Supervision & Regulation, Federal Reserve Board, Washington, District of Columbia 20551)

  • Weiling Liu

    (Department of Finance, Northeastern University, Boston, Massachusetts 02115)

Abstract

We propose a novel measure of intermediary risk exposure based on the fraction of all trade that is conducted between dealers, called the interdealer trade (IDT) measure. Intuitively, when dealers’ aggregate risk exposure rises, they trade more with each other to redistribute inventory shocks. Consistent with risk exposures relating to expected returns, market-specific IDT measures add incremental return predictability across five different markets. For example, one-standard-deviation increases in the Treasury and foreign exchange (FX) IDT measures, respectively, forecast a 1.8% higher annual excess return on a five-year bond and a 3.7% higher annual excess return on currency-specific FX trades.

Suggested Citation

  • Chris Anderson & Weiling Liu, 2024. "Inferring Intermediary Risk Exposure from Trade," Management Science, INFORMS, vol. 70(10), pages 6966-6982, October.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:10:p:6966-6982
    DOI: 10.1287/mnsc.2021.01831
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