Comparability of Impact Decay and Risk Relaxation Timescales in FX Market Making

Establish whether at least a component of the transient market‑impact decay induced by execution in interbank foreign‑exchange markets occurs on a timescale comparable to the inventory risk relaxation arising from client‑flow dynamics in over‑the‑counter FX dealer market making.

Background

The paper studies optimal FX dealer market making when hedging in the interbank market generates transient price impact, modeled with an exponentially decaying resilience state, and contrasts this with the commonly used Almgren–Chriss framework that assumes permanent impact. Empirically, market impact is transient and highly persistent, while the risk relaxation timescale for FX dealers is short, making permanent impact plausible over the risk horizon.

Motivated by the possibility that execution trades may be absorbed into other market makers’ inventories, the authors raise the question of whether part of the impact decay operates on the same timescale as risk relaxation. If true, this would highlight the importance of the interaction between impact resilience and risk management in determining optimal quoting and hedging strategies.