Explaining the bid-ask spread in the foreign exchange market: a test of alternate models

Treepongkaruna, Sirimon, Brailsford, Tim and Gray, Stephen (2013) Explaining the bid-ask spread in the foreign exchange market: a test of alternate models. Australian Journal of Management, OnlineFirst 1-20. doi:10.1177/0312896213499028

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Author Treepongkaruna, Sirimon
Brailsford, Tim
Gray, Stephen
Title Explaining the bid-ask spread in the foreign exchange market: a test of alternate models
Journal name Australian Journal of Management   Check publisher's open access policy
ISSN 0312-8962
1327-2020
Publication date 2013-09-25
Year available 2013
Sub-type Article (original research)
DOI 10.1177/0312896213499028
Open Access Status Not Open Access
Volume OnlineFirst
Start page 1
End page 20
Total pages 20
Place of publication London, United Kingdom
Publisher Sage Publications
Language eng
Formatted abstract
This paper attempts to uncover the determinants of the dealer bid-ask spread in the foreign exchange market. Prior research has examined the Huang–Masulis model wherein the spread is modelled as a function of dealer competition and volatility. We first extend this model to a much larger set of quote data covering several currencies over five years. A more recent model of the bid-ask spread has been proposed (BSW) wherein the spread is modelled as a function of order-processing costs, inventory-holding costs, adverse selection and competition. This model has not previously been tested in the foreign exchange market and this study conducts such a test. We find general support for both models using individual currency samples and a pooled sample. Of note, we find strong evidence for the relevance of the inventory-holding premium on the size of the dealer bid-ask spread. To compare the two models we undertake out-of-sample forecasts of the spread and find evidence that favours the BSW model in the aggregated sample, while the evidence is mixed in relation to individual currencies.
Keyword Bid-ask spread
Foreign exchange
Inventory-holding premium
Microstructure
Q-Index Code C1
Q-Index Status Confirmed Code
Institutional Status UQ
Additional Notes Published online before print September 25, 2013

Document type: Journal Article
Sub-type: Article (original research)
Collections: Official 2014 Collection
UQ Business School Publications
 
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Created: Thu, 31 Oct 2013, 00:40:13 EST by Karen Morgan on behalf of UQ Business School