The Future of the Foreign Exchange Market

This paper addresses the future of the foreign exchange market using two organizing (and provocative) ideas. One pertains to the market’s institutional structure, the other to its information structure. The first organizing idea is that the structure of currency markets is driven primarily by the management of credit risk. This contrasts with drivers identified by micr ostructure theory (such as management of market risk, attenuation of asymmetric information, and entry barriers). The second organizing idea is that price variation in spot currency markets is driven primarily by dispersed information. This too contrasts with the orthodox view, under which exchange rates are determined from public information. Though provocative, these two ideas are vital to understanding this market’s future. Based on drivers of the market’s current structure, I propose three scenarios for future evolution. The scenario I consider most likely is one in which the current dealer structure is maintained through dealing banks’ crosssubsidizing their liquidity provision using gains from superior order flow information.