Identifying speculators in the FX market: A microstructure approach

Abstract

This paper suggests a methodology for identifying speculators in FX (foreign exchange) markets. A player is identified as a speculator only if his speculative characteristics are extreme compared with those of other players and his influence on exchange rates on outlying days is significant. Implementing the proposed methodology on Israel's FX market, which includes 366 large players, identified 58 potential speculators – almost all of them nonresident entities, local banks, and financial companies. Examining their activity based on a unique dataset for 2008–09 revealed speculators that purchased foreign currency before and/or on outlying depreciation days and sold foreign currency before and/or on outlying appreciation days. Thus, some speculators joined or initiated the trend before the outlying appreciation or depreciation days. Based on these speculators found during 2008–09, it was possible to identify similar behavior before and on outlying days during 2010, which was defined as an out-of-sample period. The proposed methodology may help market makers and regulators track speculators before and on outlying days.