An Explanation of Non-Equilibrium Currency Bid-Ask Spreads

Abstract

This paper proposes a theoretical model which is used to illustrate that transactions costs and a risk premium are not sufficient to explain the excess currency bid-ask spread. It illustrates that only in market structures that engender market power can foreign exchange dealers widen their currency bid-ask spread to exploit adverse economic forces and also exploit a relatively price inelastic demand for foreign exchange to charge higher-than-market-determined risk premiums thus charging an excess currency bid-ask spread.