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Theoretical perspective on euro liquidity
[‘The distribution of realized exchange rate volatility’]

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  • Richard K. Lyons

Abstract

Forex markets and the euroTheoretical prespectiveI provide theoretical perspective on recent findings of increased transaction costs in the new dollar-euro market relative to the prior dollar-mark market, and assess the welfare significance of this drop in liquidity. In theory, transaction costs arise from information disadvantage costs, inventory management costs, and other market-making costs (e.g., order-processing costs). A review of theoretical reasons for the underlying costs to be rising can allow one to discriminate among hypotheses for the liquidity drop. New data on public trades support a customer liquidity hypothesis, based on the idea that the ultimate providers of liquidity in this market are customers rather than market-makers. However, the hypothesis is not consistent with the totality of the evidence, and I discuss how a combination of various mechanisms can influence transaction costs and the FX market's information efficiency.–Richard K. Lyons

Suggested Citation

  • Richard K. Lyons, 2002. "Theoretical perspective on euro liquidity [‘The distribution of realized exchange rate volatility’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 17(35), pages 571-597.
    • Handle: RePEc:oup:ecpoli:v:17:y:2002:i:35:p:571-597.
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    File URL: http://hdl.handle.net/10.1111/1468-0327.00098
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    Cited by:

    1. Gabriele Galati & Kostas Tsatsaronis, 2003. "The impact of the euro on Europe's financial markets," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 12(3), pages 165-222, August.
    2. Michael Sager & Mark P. Taylor, 2008. "Commercially Available Order Flow Data and Exchange Rate Movements: Caveat Emptor," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 583-625, June.
    3. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.
    4. Reitz, Stefan & Schmidt, Markus A. & Taylor, Mark P., 2009. "Financial intermediation and the role of price discrimination in a two-tier market," Discussion Paper Series 1: Economic Studies 2009,13, Deutsche Bundesbank.

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