The Components of Electronic Inter-Dealer Spot FX Bid-Ask Spreads

Authors: McGroarty, Frank; Gwilym, Owain ap; Thomas, Stephen

Source: Journal of Business Finance & Accounting, Volume 34, Numbers 9-10, November/December 2007 , pp. 1635-1650(16)

Publisher: Wiley-Blackwell

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Abstract:

This paper applies an established bid-ask spread decomposition model to the inter-dealer spot foreign exchange market. In addition, the paper presents and tests a modified decomposition model which is specifically adapted to the features of order-driven markets and which is found to produce more plausible results than the original model. Price clustering is introduced as a new explanatory factor within this framework and is shown to be vitally important in understanding the composition of bid-ask spreads in this market.

Keywords: high frequency data; foreign exchange; market microstructure; bid-ask spreads; order driven

Document Type: Research article

DOI: http://dx.doi.org/10.1111/j.1468-5957.2007.02051.x

Affiliations: 1: The authors are respectively Lecturer in Finance, School of Management, University of Southampton; Professor of Finance, School of Management & Business, University of Wales, Aberystwyth; and Professor of Finance, Cass Business School, City University, London.

Publication date: 2007-11-01