“We devise a simple model of liquidity demand and supply to study dealers’ liquidity provision in currency markets. Drawing on a globally representative data set of currency trading volumes, we show that at times when dealers’ intermediation capacity is constrained the cost of liquidity provision increases disproportionately relative to dealer-intermediated volume. … Using various econometric approaches, we show that this nonlinear effect of dealer constraints on market liquidity primarily stems from a reduction in the elasticity of liquidity supply, rather than changes in liquidity demand.”

Find the paper and full list of authors in Journal of Financial Economics.