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Trading Activity and Foreign Exchange Market Quality

Author

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  • Kaul, Aditya
  • Sapp, Stephen

Abstract

This paper studies intraday market quality for currency pairs with very different trading characteristics, the Euro-U.S. dollar and the Canadian dollar-U.S. dollar. Two sets of tests - the first based on the ratio of long term to short term variances, and the second based on information spillovers - provide consistent conclusions regarding market quality. The variance ratio analysis shows that market quality is highest for the Euro during European trading and lowest during Asian trading. For the Canadian dollar, market quality is highest during North American trading and lowest during Asian trading. Analysis of information spillovers shows that innovations in returns and volatility for the more heavily-traded Euro predict returns and volatility for the Canadian dollar during Asian and European trading, but innovations for the dollar have predictive power for the Euro during North American trading. Our results suggest that foreign exchange market quality is high, not always when quoting and trading activity are heavy but rather, and somewhat unexpectedly, when activity is not only high, but also geographically focused and concentrated among a limited number of major dealers.

Suggested Citation

  • Kaul, Aditya & Sapp, Stephen, 2005. "Trading Activity and Foreign Exchange Market Quality," CEI Working Paper Series 2005-9, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
    • Handle: RePEc:hit:hitcei:2005-9
    Note: Version: October 24, 2005
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    File URL: https://hermes-ir.lib.hit-u.ac.jp/hermes/ir/re/13480/wp2005-9a.pdf
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    References listed on IDEAS

    as
    1. Martin D. D. Evans, 2002. "FX Trading and Exchange Rate Dynamics," Journal of Finance, American Finance Association, vol. 57(6), pages 2405-2447, December.
    2. Martin D. D. Evans, 2017. "FX Trading and Exchange Rate Dynamics," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 5, pages 189-245, World Scientific Publishing Co. Pte. Ltd..
    3. Sapp, Stephen G., 2002. "Price Leadership in the Spot Foreign Exchange Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(3), pages 425-448, September.
    4. Biais, Bruno & Hillion, Pierre, 1994. "Insider and Liquidity Trading in Stock and Options Markets," The Review of Financial Studies, Society for Financial Studies, vol. 7(4), pages 743-780.
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    Cited by:

    1. Simone Bianco & Roberto Reno, 2009. "Unexpected volatility and intraday serial correlation," Quantitative Finance, Taylor & Francis Journals, vol. 9(4), pages 465-475.
    2. Simone Bianco & Roberto Ren'o, 2006. "Unexpected volatility and intraday serial correlation," Papers physics/0610023, arXiv.org.

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