Foreign Exchange Trading Research Articles

Exchange rate uncertainty and trade growth?a comparison of linear and non-linear (forecasting) models

A huge body of empirical and theoretical literature has emerged on the relationship between foreign exchange (FX) uncertainty and international trade. Empirical findings about the impact of FX uncertainty on trade figures are at best weak and often ambiguous with respect to its direction. Almost all empirical contributions assume and estimate a linear relationship. Possible nonlinearity or state dependence of causal links between FX uncertainty and trade has been mostly ignored yet. In addition, widely used regression models have not been evaluated in terms of ex-ante forecasting. In this paper we analyse the impact of FX uncertainty on sectoral categories of multilateral exports and imports for 15 industrialized economies. We particularly provide a comparison of linear and non-linear models with respect to ex-ante forecasting. In terms of average ranks of absolute forecast errors non-linear models outperform both, a common linear model and some specification building on the assumption that FX uncertainty and trade growth are uncorrelated. Our results support the view that the relationship of interest might be non-linear and, moreover, lacks of homogeneity across countries, economic sectors and when contrasting imports vs exports. Copyright © 2005 John Wiley & Sons, Ltd.

Czech Economy: First Year after the EU Entry

In 2004, the Czech economy continued in solid growth. Slight acceleration of economic growth was driven in particular by strong investment demand and improving performance of the foreign trade with goods. On the other hand, due to slowdown in real wages, consumer demand weakened. 2004 was the year of turnover in foreign trade which has reported the best results since 1994. The EU entry was an important factor behind the improvement of trade balance - the foreign trade exchange significantly accelerated after the EU accession. The EU entry opened new chances to the exporters, especially small and medium-sized companies could fully use the advantage of the Single Market. With the trade balance improving, the reason for permanently high current account deficit is the growing deficit of income balance as a consequence of strong FDI inflow. January and May changes in the Value Added Tax brought a temporary speed-up of consumer prices. After the absorption of this increase, since the last quarter of 2004, headline inflation has been declining. Similar to previous years, inflation fell under the CNB target corridor. Record high world prices of oil and metals caused a strong increase of industrial producer prices, however, strong competition between both producers and traders has prevented the spillover to consumer prices.

System for foreign exchange trading using genetic algorithms and reinforcement learning

Foreign exchange trading has emerged recently as a significant activity in many countries. As with most forms of trading, the activity is influenced by many random parameters so that the creation of a system that effectively emulates the trading process will be very helpful. A major issue for traders in the deregulated Foreign Exchange Market is when to sell and when to buy a particular currency in order to maximize profit. This paper presents novel trading strategies based on the machine learning methods of genetic algorithms and reinforcement learning.

Expectation formation mechanisms, profitability of foreign exchange trading and exchange rate volatility

An attempt is made to identify the expectation formation mechanism dominating the foreign exchange market and to demonstrate that exchange rate volatility can be attributed to the heterogeneity of traders with respect to expectation formation. The criterion used to identify the dominance of a particular mechanism is the profitability of trading based on that mechanism. It is concluded that mixed and extrapolative expectations are the dominant mechanisms, that market participants follow some sort of a herd behaviour, and that they pay attention to the expectations of other participants. It is also found that the heterogeneity of market participants with respect to expectation formation goes a long way towards explaining volatility.

Electronic frontiers in foreign exchange trading

In pursuit of the $1.2-trillion-a-day opportunity.

Adaptive systems for foreign exchange trading

Foreign exchange markets are notoriously difficult to predict. For many years academics and practitioners alike have tried to build trading models, but history has not been kind to their efforts. C...

Perceptions of Successful Traders by Foreign Exchange Professionals

This exploratory study examines which characteristics are perceived to be important for a successful foreign exchange trader. The findings are based on ratings by 291 professional traders at leading European banks. A factor analysis of ratings results in eight primary factors: disciplined cooperation, tackling decisions, market meaning making, emotional stability, information processing, interested integrity, autonomous organization, and handling information. Differing work location, type of foreign exchange instrument, and trading area resulted in significant differences regarding the perceived importance of these factors. Contributing to a differentiated understanding of market participants, results suggest the need for systematic job analyses of traders and may lead to more valid methods of hiring.

Tobin Tax Effects Seen from the Foreign Exchange Market's Microstructure

AbstractThere are strong calls for the introduction of a ‘Tobin tax’ on foreign exchange (FX) transactions. Despite its popularity, research has not yet made full use of available insights from the recent microstructure literature. The role of banks in FX trading is quite different from the assumptions of proponents. Asset managers are most probably the group with the heaviest influence on shorter‐term exchange rate movements. They speculate under comparatively longer horizons than FX dealers, although their behaviour also tends to be short‐termist. We argue that there is no tax rate that could both influence their behaviour and simultaneously maintain the desired high level of liquidity. We conclude that no uniform proportional Tobin tax can achieve its objectives.

Mood in foreign exchange trading: Cognitive processes and performance

This paper examines the effects of mood on the behavior of traders or decision makers in financial markets. Based on a review of the psychological theories and empirical findings which relate mood to decision making and information processing, we derive hypotheses with respect to the impact of good, neutral, and bad moods on the behavior of traders. Two experiments ( N=66 and 72) were conducted on an Internet platform which simulated foreign exchange trading based on historical market data. The first experiment manipulated mood using feedback and music whereas the second one asked subjects to read mood-laden statements. It was found that traders in a good mood had an inferior trading performance (losing money) compared to those in a neutral or bad mood (making profit). This is because traders in a good mood made less accurate decisions than those in neutral or bad moods. Those in a bad mood were the most accurate in their decisions but behaved conservatively in their trading. Subjects in a good mood tended to make less accurate decisions though they spent on average at least the same time as the other subjects on information processing and decision-making. They also were over-confident taking unwarranted risks. The studies concluded with insights concerning the effects of mood on choice of trading strategies.

Knowledge Retention and Personnel Mobility: The Nondisruptive Effects of Inflows of Experience

Firms often bring in personnel from rivals to gain tacit knowledge and skills. Personnel new to a firm may broaden the firm's knowledge stock, but may not disrupt the firm's ways of organizing. Instead, personnel inflows may contribute to the retention of a firm's traditional ways of organizing. This study tracks the flow of personnel within and across organizational boundaries (intrafirm and interfirm flows) and geographic boundaries (local and cross-border flows) for multiunit banks operating in the Foreign Exchange Trade Industry from 1973–1993. We test how a firm's retention activity responds to inflows of personnel from different sources (e.g., intrafirm, interfirm, local, and cross-border). The findings show that inflows of personnel from different sources increase a firm's retention activity. Rather than adopting changes in behavior in response to an influx of personnel from within or across spatial boundaries, firms in the foreign exchange industry tend to retain their existing ways of organizing. Personnel inflows from a combination of sources, such as local intrafirm, cross-border intrafirm, local interfirm, and cross-border interfirm, also positively affect retention. By examining the differences in the magnitudes of these effects, we empirically show that considering different sources of personnel inflows in combination is worthwhile.

Informed trade in spot foreign exchange markets: an empirical investigation

This paper presents new evidence on information asymmetries in inter-dealer FX markets. We employ a new USD/DEM data set covering the activities of multiple dealers over one trading week. We utilise and extend the VAR structure introduced in Hasbrouck [J. Finance 46(1) (1991) 179] to quantify the permanent effects of trades on quotes and show that asymmetric information accounts for around 60% of average bid-ask spreads. Further, 40% of all permanent price variation is shown to be due to transaction-related information. Finally, we uncover strong time-of-day effects in the information carried by trades that are related to the supply of liquidity to D2000-2; at times when liquidity supply is high, individual trades have small permanent effects on quotes but the proportion of permanent quote variation explained by overall trading activity is relatively high. In periods of low liquidity supply the converse is true—individual trades have large permanent price effects but aggregate trading activity contributes little to permanent quote evolution.

Information sources, news, and rumors in financial markets: Insights into the foreign exchange market

This article presents empirical findings on collective information processing in financial markets. Results are based on a questionnaire survey with 321 traders and 63 financial journalists from leading banks and financial news providers in the European foreign exchange market. Rating each other as the most important information source, foreign exchange traders and financial journalists are engaged in a circular pattern of market information processing, in which trading participants and financial news services form an interdependent relationship. Recent developments in technology have profoundly changed the nature of reporting and the role of news media in the foreign exchange market. Traders rate the speed of news and its anticipated impact on other market participants as more important than its perceived accuracy. These findings may help explain the role played by rumors in financial markets.

Productivity and the ('Synthetic') Euro-Dollar Exchange Rate

This paper analyses the impact of productivity developments in the United States and the euro area on the euro-dollar exchange rate. The paper presents a new measure of relative average labour productivity (ALP), which does not suffer from the biases implicit in readily available relative ALP data. Importantly, the patterns of these series differ widely. Employing the Johansen cointegration framework, four Behavioural Equilibrium Exchange Rate models are estimated using four different productivity proxies. Our results indicate that the extent to which productivity can explain the euro depreciation varies with the productivity proxy used: readily available measures explain most, our new, preferred measure least. If foreign exchange traders used the former to assess productivity developments, this might thus have contributed to the weakness of the euro in 2000/2001. In all models, however, productivity can explain only a fraction of the actual euro depreciation experienced in 1999/2000.

Do Momentum Traders Profit from Central Bank Intervention in Australia?

A number of recent studies have attributed the success of technical trading strategies in foreign exchange markets to central bank intervention. Arguments advanced in favour of this hypothesis contend that intervention is conducted to maintain orderly market conditions - not to make money - and as such, central banks may be willing to take a loss on their intervention operations. This paper investigates the relationship between momentum based trading profits and intervention by the Reserve Bank of Australia (RBA) in the U.S. Dollar - Australian Dollar ($US/$A) market. As the RBA's intervention policy underwent several regime shifts throughout the course of the study, the analysis should provide better insights into this relationship than has been possible in similar studies involving other central banks. This paper demonstrates that whilst a simple momentum trading rule is largely unprofitable in the absence of RBA intervention, it generates very attractive returns when taking positions in the opposite direction to the RBA during periods of intervention. The most profitable opportunities occur when the RBA attempts to smooth or correct a strong trend in the $A (particularly an aggressive depreciation) over successive days. This suggests that on occasions where the RBA 'leans against the wind', public resources are lost to speculators following momentum trading strategies. As such, the results from this study have important implications for both monetary authorities and foreign exchange traders.

The euro versus the dollar: will there be a struggle for dominance?

The international role of a national currency has many dimensions. In domains such as foreign-exchange trading, single-currency dominance can be expected, and there is no evidence that the euro is displacing the dollar. In domains such an portfolio management, diversification can be expected, and the advent of the euro is having discernable effects. In still other domains, such as reserve management, outcomes depend on these two tendencies jointly; the currency-composition of reserved depends on the roles of various currencies in foreign-exchange trading but also depends on the forces governing other forms of portfolio management. Thus far, however, the reserve role of the euro has not much exceeded that of the deutsche mark. The paper predicts a growing role for the euro in the monetary and currency regimes of countries that will soon join the EU but finds no reason to believe that the euro will displace the dollar as the main international currency.

Foreign exchange trading models and market behavior

The contributions of this paper are twofold. First, the performance of a widely used commercial real-time trading model is compared with a simple exponential moving average model. Second, the trading models are used as diagnostic tools to evaluate the statistical properties of foreign exchange rates. The results presented in this paper have a general message to the standard paradigm in econometrics. It is not sufficient to develop sophisticated statistical processes and choose an arbitrary data frequency (e.g. one week, one month, annual, etc.) claiming afterwards that this particular process does a “good job” of capturing the dynamics of the data generating process. In financial markets, the data generating process is a complex network of layers where each layer corresponds to a particular frequency. A successful characterization of such data generating processes should be estimated with models whose parameters are functions of intra and inter frequency dynamics. In other fields, such as in signal processing, paradigms of this sort are already in place. Our understanding of financial markets would be increased with the incorporation of such paradigms into financial econometrics. Our trading models, within this perspective, help to observe this subtle structure as a diagnostic tool.

The dynamics of knowledge flows: human capital mobility, knowledge retention and change

This empirical paper investigates the relationships between the amount of human capital that flows into a firm and two activities underlying a firm’s knowledge production, variation or change and knowledge retention. We track the flow of human capital within and across organizational and geographic space for all multi‐unit banks operating in the world foreign exchange trade industry from 1973 to 1993. The findings indicate that an increased reliance on past experience reduces how much human capital a firm imports in the future. This effect is moderated by a self‐reinforcing cycle of human capital inflow. Inflows of human capital also decline when a firm has recently adopted novel changes in its operations. The paper uses evolutionary thinking to define a model for intrafirm knowledge production.

Knowledge-intensive genetic discovery in foreign exchange markets

This paper considers the discovery of trading decision models from high-frequency foreign exchange (FX) markets data using genetic programming (GP). It presents a domain-related structuring of the representation and incorporation of semantic restrictions for GP-based searching of trading decision models. A defined symmetry property provides a basis for the semantics of FX trading models. The symmetry properties of basic indicator types useful in formulating trading models are defined, together with semantic restrictions governing their use in trading model specification. The semantics for trading model specification have been defined with respect to regular arithmetic, comparison and logical operators. This study also explores the use of two fitness criteria for optimization, showing more robust performance with a risk-adjusted measure of returns.

Evaluation of Currencies in the Foreign Exchange Market: Attitudes and Expectations of Foreign Exchange Traders

Summary: This article examines whether there is a connection between the attitudes of traders in the foreign exchange market and their expectations of future exchange rate developments. A psychological understanding of expectations is contrasted to the prevailing economic view of rational expectations. Findings are based on a questionnaire survey of 321 foreign exchange traders in Austria, Germany, Switzerland, and the UK. Factor analyses of semantic differential ratings of currencies result in three main factors on which currencies are evaluated. Foreign exchange traders of smaller countries (Austria, Switzerland) evaluate their home currency more positively than do other traders. Positive attitudes toward a currency correlate with expectations of currency appreciation. Social Identity Theory helps to explain the observed differences in evaluations of domestic currencies. In order to better understand financial markets, the economic assumption that expectations of market participants are unbiased and rational has to be replaced by a psychology of human market expectations.

Currency traders and exchange rate dynamics: a survey of the US market

We report findings from a survey of United States foreign exchange traders. Our results indicate that: (i) in recent years electronically-brokered transactions have risen substantially, mostly at the expense of traditional brokers; (ii) the market norm is an important determinant of interbank bid-ask spread and the most widely-cited reason for deviating from the conventional bid–ask spread is a thin/hectic market; (iii) half or more of market respondents believe that large players dominate in the dollar–pound and dollar–Swiss franc markets; (iv) technical trading best characterizes about 30% of traders, with this proportion rising from five years ago; (v) news about macroeconomic variables is rapidly incorporated into exchange rates; (vi) the importance of individual macroeconomic variables shifts over time, although interest rates always appear to be important; (vii) economic fundamentals are perceived to be more important at longer horizons, while short-run deviations from the fundamentals are attributed to excess speculation and institutional customer/hedge fund manipulation; (viii) speculation is generally viewed positively, as enhancing market efficiency and liquidity, even though it exacerbates volatility; (ix) central bank intervention does not appear to have a substantial effect, although there is general agreement that it increases volatility, and finally; (x) traders do not view purchasing power parity as a useful concept, even though a significant proportion (40%) believe that it affects exchange rates at horizons of over six months.