A SIMULTANEOUS TRADE MODEL OF THE FOREIGN-EXCHANGE HOT POTATO

This paper develops a simultaneous trade model of the spot foreign exc hange market (cf., the sequential trade approach to dealing). The mode l produces hot-potato trading - a term that refers to the repeated pas sing of inventory imbalances between dealers. At the outset, risk-aver se dealers receive customer orders that are not generally observable. Dealers then trade among themselves. Thus, each dealer intermediates b oth his customers' trades and any information contained therein. This information is subsequently revealed in price depending on the informa tion in interdealer trades. We show that hot-potato trading reduces th e information in interdealer trades, making price less informative.