C. Holden, Dong Lu, Volodymyr Lugovskyy, D. Puzzello
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What is the Impact of Introducing a Parallel OTC Market? Theory and Evidence from the Chinese Interbank FX Market
Chinese Interbank Foreign Exchange trading was originally conducted through a centralized, anonymous limit order book (LOB). We determine the impact of the introduction of a parallel decentralized over-the-counter (OTC) market. We find that: (1) most trading migrated to the OTC, (2) the LOB price function is upward-sloping versus the OTC price function is downward-sloping, and (3) the LOB market has a single price function versus the OTC market has multiple price functions. Next, we develop a theoretical model of parallel markets that can simultaneously explain all of these empirical findings. We test a new model prediction and find support.
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