Template-Type: ReDIF-Paper 1.0
Author-Name: Athanasios Geromichalos
Author-Name-First: Athanasios
Author-Name-Last: Geromichalos
Author-Name: Kuk Mo Jung
Author-Name-First: Kuk Mo
Author-Name-Last: Jung
Author-Workplace-Name: Department of Economics, University of California Davis
Title: An Over-the-Counter Approach to the FOREX Market
Abstract: The FOREX market is an over-the-counter market (in fact, the largest in the world) characterized
 by bilateral trade, intermediation, and significant bid-ask spreads. The existing international
 macroeconomics literature has failed to account for these stylized facts largely due to
 the fact that it models the FOREX as a standard Walrasian market, therefore overlooking some
 important institutional details of this market. In this paper, we build on recent developments
 in monetary theory and finance to construct a dynamic general equilibrium model of intermediation
 in the FOREX market. A key concept in our approach is that immediate trade between
 buyers and sellers of foreign currencies is obstructed by search frictions (e.g., due to geographic
 dispersion). We use our framework to compute standard measures of FOREX market liquidity,
 such as bid-ask spreads and trade volume, and to study how these measures are affected
 both by macroeconomic fundamentals and the FOREX market microstructure. We also show
 that the FOREX market microstructure critically affects the volume of international trade and,
 consequently, welfare. Hence, our paper highlights that modeling the FOREX as a frictionless
 Walrasian market is not without loss of generality.
Length: 50
File-URL: https://repec.dss.ucdavis.edu/files/CH1nExHkievNuxfp6n8CTR6y/14-4.pdf
File-Format: application/pdf
Number: 156
Classification-JEL: D4, E31, E52, F31
KeyWords: FOREX market, over-the-counter markets, search frictions, bargaining, monetarysearch models
Creation-Date: 20141111
Handle: RePEc:cda:wpaper:156