The impact of different players on the volume-volatilityrelation in the foreign exchange market

Abstract

AbstractWe examine the volume-volatility relation in the foreign exchange (FX) mar-ket using a unique data set from the Swedish krona (SEK) market thatcontains observations of 90-95 percent of all transactions from 1995 until2002. Due to the lack of data, few results have been presented for the FXmarket. Furthermore, most studies use only aggregated series, and cannotdistinguish between the impact of different market participants. Our data isdisaggregated on a number of Market making banks’ buying and selling withfour different counterparties (Financial or Non-Financial customers, the Cen-tral Bank and Market making banks) and in five different instruments. Weshow that the strength of the volume-volatility relation depends on the groupof market participants trading. Financial trading volume has the highestcorrelation with volatility. Interbank trading between the two largest Mar-ket making banks is also positively correlated with volatility, while tradingamong Other banks show no correlation with volatility. Trading by Non-Financial customers is not correlated with volatility at all when controllingfor trading by other market participants. Interestingly, we show that (un-expected) spot volume and changes in net positions (spot and forward) byFinancial customers Granger cause spot volume and changes in net positionsby Non-Financial customers.Keywords: Volume-volatility relation, microstructure, exchange ratesJEL Classification: F31