| China has abrogated FX (Foreign Exchange) double prices since the reform of FX market in 1994, which established an exchange-traded inter-bank FX market strongly regulated by the government. In contrast to China, major international FX markets are OTC ones, with FX dealers playing a key role in transactions and the decision of exchange rate. This difference urges us to consider: is a dealer market more efficient than an exchange-traded market? If yes, what are its major advantages? Furthermore, is it recommendable for China to reconstruct a dealer FX market in the future? In order to answer these questions, we should reflect on the choice of exchange system from an economic perspective, and give answers to following questions:1) What is the definition of the "efficiency" of FX market? What is the criterion of the efficiency of FX market?2) By that criterion, why major FX markets are dealer markets? How can a dealer market enhance market efficiency? What are the prerequisites to an efficient dealer market, if there is any at all?3) What are the major disadvantages of the present exchange-traded FX market in China? Is an OTC dealer market a good recommendation to overcome the disadvantages?4) Can China meet the prerequisites to an efficient dealer market at present? If not, what are the needed reforms?The analysis provides a preliminary theoretical framework, as well as some helpful advice in policymaking, is of notable importance.Based on the reality, this paper employs economic theory to analyze preceding questions. First, we brought forward the criterion of FX market based on economic theory; then we discussed the competitive efficiency of FX dealers; finally, we came to Chinese FX market, giving some advice on the future reforms on FX market system.Following preceding logic, this paper is in four chapters:Chapter 1 gives a brief description of modern FX market, and thenbrings forward the definition and criterion of efficiency of FX market.Chapter 2 explains why major FX market are OTC ones, and how dealers enhance efficiency. As conclusion of this chapter we give the criterion of FX market efficiency.Chapter 3 gives a brief review of the development of Chinese FX market, and discusses the major defects of present FX market system in the background of further open-up of China's economy.Chapter 4 reflects on the necessity of establishment of a dealer FX market in China, and then gives advice on policymaking.The chief conclusions of this paper are as following:1) Theoretically, efficiency of FX market is defined as the measure of the actual benefit from exchange in relative to the potential benefit, which can be judged by the proximity of the market price of FX to its "real price", viz. the present value of the net cash flow from FX assets. In a real world, efficiency depends on the competition in the market as well as the level of transactional costs.2) The choice of exchange system depends on the characteristics of the financial assets transacted. OTC market is appropriate for FX transaction because information affecting FX rate is quite open to most investors, and the FX supply is perfect elastic. While dealers enhance efficiency by providing transaction immediacy and soothing temporal fluctuation of FX price, some prerequisite must be fulfilled:① Dealers are risk-averse, and their utility is positively related to the expected total wealth.② Dealers are not restricted to make choice on the portfolio and the timing of FX transaction.③ There are enough dealers operating in the market, none of them is in monopoly.④Market information ( including price, volume, etc.) is open to all dealers, none of them dominate others as regards to information.3) The present Chinese FX market features an insular exchange-traded one strongly regulated by the government. The present FX market system goes against efficiency in some aspects, such as:① The small scope of the exchange-traded market and its high cost. Meanwhile, the compulsory exchange tra... |
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