Spot Foreign Exchange Research Articles

Understanding FX Liquidity

We provide a comprehensive study of the liquidity of spot foreign exchange (FX) rates over more than two decades and a large cross-section of currencies. First, we show that FX liquidity can be accurately measured with daily and readily-available data. Second, we demonstrate that FX liquidity declines with funding constraints and global risk, supporting theoretical models relating funding and market liquidity. In these distressed circumstances, liquidity tends to evaporate more for developed and riskier currencies. Finally, we show stronger comovements of FX liquidities in distressed markets, especially when funding is constrained, volatility is high, and FXspeculators incur losses.The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2614853

Developing High-Frequency Foreign Exchange Trading Systems

The foreign exchange (FX) spot markets are well suited to high frequency trading. They are highly liquid, allow leverage, and trade 24 hours a day, 5 days a week. This paper documents and tests the stylized facts known about high-frequency FX markets. It then postulates a high frequency trading system on the basis of these stylized facts. Benchmarking confirms the robustness of the approach, demonstrating the role algorithmic trading has to play in higher frequency trading environments.

Order Flow and the Real: Indirect Evidence of the Effectiveness of Sterilized Interventions

This study presents indirect evidence of the effectiveness of sterilized interventions in Brazil based on the complete records of daily customer order flow data reported by Brazilian dealers, as well as foreign exchange intervention data over a time span of 10 years (2002-2011). We find that the effect of USD sales by end-users on the BRL/USD was much stronger on days in which the BCB did not intervene in the spot foreign exchange market.

Search Costs: The Neglected Spread Component

Author(s): Flood, Mark D.; Huisman, Ronald; Koedijk, Kees G.; Lyons, Richard K. | Abstract: Dealers need to search for quotes in many of the world's largest markets (such as spot foreign exchange, US government bonds, and the London Stock Exchange). This search affects trading cost. We estimate the share of total trading cost attributable to search. Our experiments show that the share is large -- roughly one-third of the effective spread. Past work on estimating spread components typically omits the search component. Our estimates suggest this omission is important.

Foreign exchange market reactions to sovereign credit news

We analyse the reaction of the foreign exchange spot market to sovereign credit signals by Fitch, Moody’s and S&P during 1994–2010. We find that positive and negative credit news affects both the own-country exchange rate and other countries’ exchange rates. We provide evidence on unequal responses to the three agencies’ signals. Fitch signals induce the most timely market responses, and the market also reacts strongly to S&P negative outlook signals. Credit outlook and watch actions and multiple notch rating changes have more impact than one-notch rating changes. Considerable differences in the market reactions to sovereign credit events are highlighted in emerging versus developed economies, and in various geographical regions.

The optimal interval partition and second-factor fuzzy set bi on the impacts of fuzzy time series forecasting

This study uses two sets of Taiwanese data, the export values as the prediction varialbe and its foreign exchange spot rates as the auxiliary variable, to discuss two important issues of forecastin...

Criteria for Broadening the SDR Currency Basket

The paper explores the pros and cons of maintaining the current “freely usable currency” criterion, and clarifies indicators for assessing it. The freely usable concept and its two key elements—currencies should be "widely used" and "widely traded"—are set out in the Articles and serve important operational purposes. A formal requirement for a currency to be freely usable was adopted for SDR valuation only in 2000, although considerations relating to this concept had been taken into account earlier. Indicators for assessing freely usable currencies were first discussed in 1977, and are updated to reflect subsequent developments in financial markets and data availability. The paper suggests as indicators for "wide use" the currency composition of foreign exchange reserves, international debt securities, and international bank liabilities; and for "wide trading" it proposes foreign exchange spot market turnover.

An Empirical Analysis on the Lead-Lag Relationship between Foreign Exchange Futures Market and Spot Market

An Empirical Analysis on the Lead-Lag Relationship between Foreign Exchange Futures Market and Spot Market

Price Discovery and Transmission Mechanism between CDS and FX markets

This study investigated the relationship between the CDS (credit default swap) market with the FX spot (FX swap) market, including the period of recent global financial crisis. A measure for market efficiency is the condition that the derivative markets dominate the asset market in price discovery. In our case, however, FX market should be leading the CDS market. We found FX (spot and Derivatives) market has co-integration relationship with CDS market. Looking at Gonzalo Granger (GG) and Hasbrouck's price discovery measure, we found the FX spot and derivatives market dominated CDS market in price discovery. This study has also examined the direction of shock spillover and volatility transmission between Korean CDS spread and Foreign exchange spot (FX swap) markets using the VECM bivariate GARCH approach. Our evidence suggested the presence of bi-directional shock volatility and volatility transmission between the CDS market and FX spot market partially exist. However, volatility spillover effects from CDS market to FX Swap market are stronger than in the reverse direction during the global financial crisis, indicating that the CDS spread signaling sovereign risk play a more important role in influencing the volatility of FX derivatives market. There are some particular features in FX market. The volatility and shock of CIP deviations reflecting arbitrage opportunities in FX swap market are influenced by those of CDS spread in tranquil period prior to Lehman failure. But after Lehman failure CDS played a crucial role in signaling credit risk in FX derivatives market. We found that higher liquidity and trading volume of market matters more in price discovery and information transmission.

A General Computation Scheme for a High-Order Asymptotic Expansion Method

This paper presents a new computational scheme for an asymptotic expansion method of an arbitrary order. An asymptotic expansion method in finance initiated by Kunitomo and Takahashi[9], Yoshida[34] and Takahashi [20], [21] is a widely applicable methodology for an analytic approximation of the expectation of a certain functional of diffusion processes and not only academic researchers but also many practitioners have used the methodology for a variety of financial issues such as pricing or hedging complex derivatives under highdimensional underlying stochastic environments. In practical applications of the expansion, the crucial step is calculation of conditional expectations for a certain kind of Wiener functionals. [20], [21] and Takahashi and Takehara [23] provided explicit formulas of conditional expectations necessary for the asymptotic expansion up to the third order. This paper presents the new method for computing an arbitrary-order expansion in a general diffusion-type stochastic environment, which is powerful especially for a high-order expansion: This develops a new calculation algorithm for computing coefficients of the expansion through solving a system of ordinary differential equations that is equivalent to computing the conditional expectations. To demonstrate its effectiveness, the paper gives numerical examples of the approximation for the λ-SABR model up to the fifth order and a cross-currency Libor market model with a general stochastic volatility model of the spot foreign exchange rate up to the fourth order.

Valuation of European Currency Options in Financial Engineering

In this paper, we try to solve the valuation of currency option in financial engineering. We use a generalized jump-diffusion system to describe the spot Foreign Exchange (FX) rate and apply regime switching model to describe the domestic and foreign risk-free interest rate and the appreciation rate and the volatility. And the regime switching model is based on a continuous time finite state Markov process. Under the minimal martingale measure, we obtain a system of partial-differential-integral-equations satisfied by the European currency option prices. Our model provides the flexibility to model different kinds of dynamics in FX rate. At last, we present a simulation of option pricing with the special case of compound Poisson jump and we can find the effects of the parameters on the prices.

Efeitos das intervenções cambiais a vista na taxa de câmbio R$/US$: o caso brasileiro de 1999 a 2008

Este estudo analisa as intervenções ocorridas no mercado cambial brasileiro entre 1999 e 2008 por meio de operações a vista e seus efeitos na taxa de câmbio R$/US$. O período foi segmentado usando os resultados de um modelo MS-VAR. Pelas de estimações GARCH foi possível identificar relação entre intervenções e câmbio, principalmente em subperíodos de menor volatilidade. Estimações com EGARCH indicam assimetria dos choques na volatilidade, os dias de intervenções relacionadas a depreciações apresentam maior efeito na volatilidade que as vinculadas a apreciações. Os resultados indicam a possibilidade de endogeneidade das intervenções. Em muitas situações a força dessas intervenções não foi suficiente para sobrepor a tendência da taxa de câmbio.

A class of Lévy process models with almost exact calibration to both barrier and vanilla FX options

Vanilla (standard European) options are actively traded on many underlying asset classes, such as equities, commodities and foreign exchange (FX). The market quotes for these options are typically used by exotic options traders to calibrate the parameters of the (risk-neutral) stochastic process for the underlying asset. Barrier options, of many different types, are also widely traded in all these markets but one important feature of the FX options markets is that barrier options, especially double-no-touch (DNT) options, are now so actively traded that they are no longer considered, in any way, exotic options. Instead, traders would, in principle, like to use them as instruments to which they can calibrate their model. The desirability of doing this has been highlighted by talks at practitioner conferences but, to our best knowledge (at least within the realm of the published literature), there have been no models which are specifically designed to cater for this. In this paper, we introduce such a model. It allows for calibration in a two-stage process. The first stage fits to DNT options (or other types of double barrier options). The second stage fits to vanilla options. The key to this is to assume that the dynamics of the spot FX rate are of one type before the first exit time from a ‘corridor’ region but are allowed to be of a different type after the first exit time. The model allows for jumps (either finite activity or infinite activity) and also for stochastic volatility. Hence, not only can it give a good fit to the market prices of options, it can also allow for realistic dynamics of the underlying FX rate and realistic future volatility smiles and skews. En route, we significantly extend existing results in the literature by providing closed-form (up to Laplace inversion) expressions for the prices of several types of barrier options as well as results related to the distribution of first passage times and of the ‘overshoot’.

Efeitos das Intervenções Cambiais à vista na Taxa de Câmbio R$/US$ de 1999 a 2008: Um Estudo de Evento

Este estudo analisa os efeitos das intervenções ocorridas no mercado cambial brasileiro através de operações a vista entre 1999 e 2008 sobre o comportamento da taxa de câmbio R$/US$ utilizando a abordagem de estudo de eventos. O período foi segmentado mediante os resultados de um modelo MS-VAR e analisado através de diferentes critérios. Foi possível identificar efeito proeminente para intervenções feitas de forma contínua, em contraste a intervenções pontuais. Há também indícios de que os efeitos no câmbio se dissipam rapidamente. A criação de um critério de avaliação referente a aceleração cambial permitiu identificar uma tendência a obtenção de sucessos nas intervenções de compras a favor da maré, servindo de indicativo de que o câmbio está mais propenso a responder a estímulos aceleracionistas na direção de depreciação cambial.

News announcements and price discovery in foreign exchange spot and futures markets

This paper studies competition in price discovery between spot and futures rates for the EUR–USD and JPY–USD markets around scheduled macroeconomic announcements. Using both the information shares approach and the common factor component weight approach for futures prices from the Chicago Mercantile Exchange (CME), as well as deal prices from spot trading on the Electronic Broking Services (EBS), we gauge how foreign exchange spot and futures markets respond to news surprises. The results show that the spot rates provide more price discovery than do the CME futures rates overall; however, the contribution of the futures rates to price discovery increases in the time surrounding macroeconomic announcement releases.

Markov-modulated jump–diffusions for currency option pricing

This paper introduces dynamic models for the spot foreign exchange rate with capturing both the rare events and the time-inhomogeneity in the fluctuating currency market. For the rare events, we use a compound Poisson process with log-normal jump amplitude to describe the jumps. As for the time-inhomogeneity in the market dynamics, we particularly stress the strong dependence of the domestic/foreign interest rates, the appreciation rate and the volatility of the foreign currency on the time-varying sovereign ratings in the currency market. The time-varying ratings are formulated by a continuous-time finite-state Markov chain. Based on such a spot foreign exchange rate dynamics, we then study the pricing of some currency options. Here we will adopt a so-called regime-switching Esscher transform to identify a risk-neutral martingale measure. By determining the regime-switching Esscher parameters we then get an integral expression on the prices of European-style currency options. Finally, numerical illustrations are given.

THE MIRAGE OF TRIANGULAR ARBITRAGE IN THE SPOT FOREIGN EXCHANGE MARKET

We investigate triangular arbitrage within the spot foreign exchange market using high-frequency executable prices. We show that triangular arbitrage opportunities do exist, but that most have short durations and small magnitudes. We find intra-day variations in the number and length of arbitrage opportunities, with larger numbers of opportunities with shorter mean durations occurring during more liquid hours. We demonstrate further that the number of arbitrage opportunities has decreased in recent years, implying a corresponding increase in pricing efficiency. Using trading simulations, we show that a trader would need to beat other market participants to an unfeasibly large proportion of arbitrage prices to profit from triangular arbitrage over a prolonged period of time. Our results suggest that the foreign exchange market is internally self-consistent and provide a limited verification of market efficiency.

Foreign exchange market prediction with multiple classifiers

AbstractForeign exchange market prediction is attractive and challenging. According to the efficient market and random walk hypotheses, market prices should follow a random walk pattern and thus should not be predictable with more than about 50% accuracy. In this article, we investigate the predictability of foreign exchange spot rates of the US dollar against the British pound to show that not all periods are equally random. We used the Hurst exponent to select a period with great predictability. Parameters for generating training patterns were determined heuristically by auto‐mutual information and false nearest‐neighbor methods. Some inductive machine‐learning classifiers—artificial neural network, decision tree, k‐nearest neighbor, and naïve Bayesian classifier—were then trained with these generated patterns. Through appropriate collaboration of these models, we achieved a prediction accuracy of up to 67%. Copyright © 2009 John Wiley & Sons, Ltd.

Computation in an Asymptotic Expansion Method

An asymptotic expansion scheme in finance initiated by Kunitomo and Takahashi [15] and Yoshida [68] is a widely applicable methodology for analytic approximation of the expectation of a certain functional of diffusion processes. [46], [47] and [53] provide explicit formulas of conditional expectations necessary for the asymptotic expansion up to the third order. In general, the crucial step in practical applications of the expansion is calculation of conditional expectations for a certain kind of Wiener functionals. This paper presents two methods for computing the conditional expectations that are powerful especially for high order expansions: The first one, an extension of the method introduced by the preceding papers presents a general scheme for computation of the conditional expectations and show the formulas useful for expansions up to the fourth order explicitly. The second one develops a new calculation algorithm for computing the coefficients of the expansion through solving a system of ordinary differential equations that is equivalent to computing the conditional expectations. To demonstrate their effectiveness, the paper gives numerical examples of the approximation for λ-SABR model up to the fifth order and a cross-currency Libor market model with a general stochastic volatility model of the spot foreign exchange rate up to the fourth order.

Segmentation and time-of-day patterns in foreign exchange markets

This paper sheds light on a puzzling pattern in spot foreign exchange markets: domestic currencies appreciate (depreciate) systematically during foreign (domestic) working hours. This phenomenon spans many years and several exchange rates, and overrides calendar effects. We argue that it is mainly due to liquidity and inventory patterns that emerge from the combination of two factors: domestic agents tend to be net buyers of foreign currency and to trade mostly in their country’s working hours. The prevalence of domestic (foreign) traders demanding the counterpart currency during domestic (foreign) working hours implies sell-price (buy-price) pressure on the domestic currency during domestic (foreign) working hours.