Abstract
This paper examines the relationship between trading activity in currency futures and exchange rate volatility. In order to measure trading activity, the paper uses both volume and open interest to distinguish between speculators/day traders and hedgers. The study uses three different measures of volatility: (1) the extreme value estimator that measures intra-day volatility; (2) historical volatility; and (3) conditional volatility from the GARCH (1, 1) process. Main finding is that speculators and day traders destabilize the market for futures. Whether hedgers stabilize or destabilize the market is inconclusive. The results suggest that speculators’ demand for futures goes down in response to increased volatility. Meanwhile, the demand from hedgers shows mixed results, depending on the method used to measure volatility.
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