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ASYMMETRIC INFORMATION AND THE CROSS-SECTION OF CURRENCY SPREADS

11/2004;

ABSTRACT This paper shows that the spreads charged by currency dealers vary inversely with deal size and that they are wider for importers and exporters than for asset managers and other dealers. This pattern is the opposite of that predicted by standard models of market making under asymmetric information, given the information structure of currency markets. The paper suggests that private information gives certain customers market power relative to their dealers. Symmetrically, it suggests that dealers strategically quote narrower spreads to privately informed customers to increase their access to information. Finally, the paper suggests that dealers primarily seek information about transitory market developments rather than fundamentals.

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