Just another day in the inter-bank foreign exchange market

In this paper, I develop a theory of bid-ask quotes provided by foreign exc hange dealers in the inter-bank market based on their beliefs and their inv entory positions. I then build an agent-based model of the inter-dealer mar ket where dealers learn in a Bayesian manner from quotes from other dealers . Using simulations, I find that the resulting intra-day spreads and betwee n-quote returns largely conform to the empirically observed intra-day U-sha ped pattern - a feature that has not been satisfactorily explained in the l iterature. I also study the factors that determine this U-shape. (C) 2000 E lsevier Science S.A. All rights reserved. JEL classification: D83; F31.