Foreign Exchange Market Participants Research Articles

Interventions in the Yen–dollar spot market: A story of price, volatility and volume

We test the effectiveness of Bank of Japan (BOJ)’s foreign exchange interventions on conditional first and second moments of exchange rate returns and traded volumes, using a bivariate EGARCH model of the Yen/USD market from 5-13-1991 to 3-16-2004. We also estimate a friction model of BOJ’s intervention reaction function based on reducing short-term market disorderliness and supplementing domestic monetary policy. Important finding of this study are that: (i) we find ineffectiveness of BOJ interventions in influencing exchange rate trends pre-1995, in general, but effectiveness post-1995; (ii) FED intervention amplified the effectiveness of the BOJ transactions; (iii) interventions amplified market volatility and volumes through a ‘learning by trading’ process; (iv) BOJ’s interventions were based on ‘leaning against the wind’ motivations on the exchange rate trend and volumes; and (v) BOJ interventions were vigorously used in support of domestic monetary policy objectives post-1995. Though some of our findings confirm recent studies, our analysis goes deeper to provide new findings with important implications for central banks and foreign exchange market participants.

European Currency Volatility After Economic and Monetary Union

Corporate and institutional foreign exchange market participants are sensitive to the effects of volatility on their day-to-day trading activities and so an important question is whether the introduction of the euro had an impact on foreign exchange rate volatility. Rather than compare individual currencies with the Euro we compare the pre 1999 volatility of three synthetic euro exchange rate series with the volatility of the actual euro starting from the 1 st of January 1999. Volatility tests are undertaken within a GARCH framework. There is evidence of a statistically significant increase in transatlantic exchange rate volatility following the introduction of the euro. Acknowledgements We would like to express our thanks to the staff in the School of Finance and Applied Statistics at the ANU, particularly Dr Chris Bilson for his support and guidance.

The Relationship Between Commodity Prices and the Australian Dollar

Australia is a major exporter of mining and agricultural commodities. These commodities are often invoiced in USD. The purpose of this study is to examine the strength of the relationship between the nominal Australian/United States exchange rate and indexed commodity prices using monthly data between 1986 and 2001. The next issue is whether or not these time series are cointegrated and whether or not uni-directional and/or two-way causality exists. An ordinary least squares regression model on unlagged data was expected to have low and spurious explanatory power, however this picture improves significantly when first difference data are used. It is found that cointegration does not exist in the level data set. However, it is found that the variables exhibit dual causality and negative correlation, with the significantly stronger causality running from commodity prices to AUD/USD exchange rate. This implies exogeneity in commodity prices. That knowledge should assist Australian commodity exporters in making firm-value decisions regarding the hedging of their foreign exchange and commodity price exposures. Because the level data do not exhibit cointegration, it cannot be concluded that long-term and systematic rational properties exist in the Australian exchange and commodity markets. However, when ordinary least squares regressions are applied to the first difference data, greater explanatory power of exchange rates and significant negative correlation is exhibited. Australian foreign exchange market-participants may use commodity price information to adjust their exchange rate expectations in the short-term in a sensible way.

Short‐Term Horizons in Foreign Exchange? Survey Evidence from dealers and Fund Managers

The paper examines the extent and determinants of short‐term horizons in taking open positions using a questionnaire mailed to professional foreign exchange market participants in Germany. The findings reveal that the absolute anticipation horizon is short, but not necessarily short‐termist. Another related but empirically different measure is proposed, based on the relative length of different horizons; its use clearly shows widespread restrictions in relation to optimal behavior. No determinants in personal characteristics were established for either empirical measure; rather the instituional environment was found to be an influence. Thus, professionals may adept rationally to their incentive structure, which works towards short‐term horizons in position taking.

Interest-Rate Arbitrage in Currency Baskets: Forecasting Weights and Measuring Risk

We use a time series modeling approach to address two related questions of interest to foreign-exchange market participants and policy makers dealing with basket currencies. First, how are unknown weights appropriately extracted from basket currencies? Second, how does one correctly account for the risk—in terms of conditional variance of expected profits—that time-varying weights add to the standard basket-hedge position? We suggest a methodology that can provide answers to these questions and apply it to the heavily traded Thai baht currency basket.

Cointegration Modeling of Expected Exchange Rates

If foreign exchange market participants form rational forecasts of future exchange rates, we should expect that these forecasts should be closely matched to subsequent realizations. Specifically, rational forecasts of a time series and the observed series itself should be cointegrated. In this paper, we apply this insight to multiple exchange rate series and a corresponding set of market expectations of future values of the exchange rate series. We build a cointegration (and associated error-correction) model of actual and expected exchange rates for five exchange rates against the U.S. Dollar, using weekly expectations data from Money Market Services, International for the 1986 - 1997 period. Our empirical work produces very strong evidence of cointegration between the exchange rate series and the expected rates series. We find strong evidence that existing work that ignores the impact of error-correction is significantly misspecified. At the shortest forecast horizon, the error-correction term dominates all other determinants of changes in expected exchange rates in our sample and indicates a sensible response by market participants to past mistakes in forecasting future rates. At longer forecast horizons, error-correction remains very important, but lagged changes in actual and expected rates also play a role. We find limited evidence of threshold effects in our error-correction models.

EURO: Past, Present and Future

The introduction of the Euro was expected to spur the creation of a stable and systemic financial system in Europe. Though the Euro's inception represented the biggest change in the international monetary system since the formation of IMF and World Bank, the currency has lost its credibility due to its continuous depreciation over the last one and half year time period. Instead of creating more opportunities for the consumers and investors, the currency has brought about fresh challenges within the euro area and in countries outside the euro area for the management of risk and financial crisis. The Euro has depreciated around 20 per cent against most of the currencies, since its adoption and this has created uncertainity among the foreign exchange market participants. While the future of the Euro cannot be readily predicted, it is not likely to appreciate over the next two years. This paper examines the exchange rate movements of Euro and its implications through an eclectic approach.

'Once-in-a-Generation' Yen Volatility in 1998: Fundamentals, Intervention, and Order Flow

The yen provided foreign exchange market participants with 'once-in-a-generation' volatility movements in 1998. For instance, after many months of uneven yen depreciation a remarkable period of yen appreciation was experienced where, in one two-day period, the U.S. dollar dropped in value by 20 yen, market-makers were refusing to quote yen/dollar prices for more than $1 million, and funds with short yen positions incurred massive losses. Not since the early 1970s has the yen-dollar exchange rate experienced such shifts. Analysts claimed that the yen reversal was due to order flow driven by changing tastes for risk and hedge-fund herding on unwinding yen 'carry trade' positions rather than any fundamentals related to the yen. In this paper, we examine the high-frequency evidence on the yen/dollar exchange rate in 1998 and provide a detailed characterization of the return volatility. Evidence of shifting fundamentals is provided by a comprehensive list of macroeconomic announcements from both the U.S. and Japan. While macroeconomic announcements and intervention are found to have significant effects on volatility, our results lead to the conclusion that order flow played a more important role than news regarding fundamentals. Evidence regarding the independent effect of order flow was provided by spot, forward, and futures positions of major market participants. These position changes are found to be significant determinants of volatility. Since such portfolio shifts are revealed to the market through trading, the results are consistent with order flow playing a significant role in the revelation of private information and the associated exchange rate shifts.

The noise trading approach — questionnaire evidence from foreign exchange

This article examines three basic assumptions of the noise trading approach via a mailed questionnaire sent to professional foreign exchange market participants in Germany. Two groups, characterized by their use of different information, can be identified: `rational arbitrageurs' relying primarily on fundamental analysis and `not-fully-rational noise traders' preferring other forms of analysis. The questionnaire further reveals the `short horizons' and `sentiments' assumed by the noise trading approach but cannot exclusively relate these to the respective groups. This conforms with the interpretation that rational participants use non-fundamental analyses to exploit less-rational noise traders.

Causes of the Recent Currency Crises in Developing Economies

This thesis analyzed the reasons of foreign currency crisis which happened in Mid-South America and South East Asia based on the economical structure of developing countries. First, it is illustrated theoretically. Since the developing countries, which maintain the export-oriented economic growth, allocates the sources in the trade area, equilibrium real exchange rate of these countries get relatively higher evaluation. Capital inflows with future exports as its necessary conditions make the foreign exchange market participants expect that the real future exchange rate will be much lower than the current equilibrium exchange rate (so called devaluation), giving rise to foreign exchange crisis. Negative debts result in the information asymmetry between creditor and debtor, and between adverse selection and moral relaxation, and that cause crisis for foreign currency and reduces their attractiveness, proposed by Mishkin. In fact developing countries in Southeast Asia and Central and South America that has the recent outbreak of a foreign exchange crisis, also have unhealthy banks. When we apply analysis mentioned above to South Korea, we can not find evidence of relatively high evaluation level on the real equilibrium exchange rate and evidence of poor management in the banking sector.

Rational expectations in the foreign exchange market? Some survey evidence

This paper uses a survey data set that includes a large cross-section of currencies to test for the rationality of expectations in the foreign exchange market. Two standard tests are applied to the data. First, a test to determine if investors make systematic forecast errors. Second, a test to determine if investors use all available information efficiently when they make their forecasts. This paper's data set involves a more recent time period which saw more quiescent exchange rate changes than the 1980s. This paper finds that participants in the foreign exchange market do make systematic forecast errors and do not always use all available information when forecasting. This conclusion is similar to past research but is now extended to a broader range of currencies and more recent time period.

How Much Are Exchange Rate Forecasts Worth?

This paper undertakes empirical tests of the ability of foreign exchange market participants to forecast the future value of the Australian dollar for one- and four-week horizons. A new set of survey data published in The Australian newspaper is used for this purpose. The accuracy of the forecasts is compared with that of the forecasts given by the random walk model which corresponds to no-change extrapolation. In general, the results indicate that no-change extrapolation is almost as good as the survey forecasts.

FORWARD EXCHANGE AND CURRENCY POSITION

THIS PAPER PRESENTS a non-mathematical, integrated model of the forward exchange market. It is based upon concepts which are applied to all foreign exchange market participants rather than upon an assigned role for each participant (speculator, arbitrager, trader). The latter approach has been nearly universal among previous non-mathematical treatments. We abstract from the influence upon the foreign exchange market of the demand and supply conditions for imports and exports, and of the forces which determine the quantity of long term capital flows. The spot rate is taken as given and changes in these forces are simply considered to be exogenous disturbances to the financial equilibrium described in the model. Analysis of the forward exchange market has traditionally been conducted within an arbitrager-speculator format where it is assumed that pure speculators and pure arbitragers are the only participants in the forward exchange market. Only pure speculators assume exchange risk by dealing only in forward exchange. In contrast, arbitragers never expose themselves to exchange risk; they only conduct simultaneous and exactly offsetting spot and forward transactions. Hence, the following aggregate relationship must hold for any twocurrency model.'