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Are banks market timers or market makers? Explaining foreign exchange trading profits

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  • Ammer, John
  • Brunner, Allan D.

Abstract

We analyze the foreign exchange trading earnings of large U.S commercial banks over the past several years. In particular, we use several approaches to try to determine to what extent these profits can be attributed either to position-taking by banks or to the provision of intermediation services to bank customers. The results can be summarized as follows. First, banks appear to generate a substantial portion of their foreign exchange earnings from making markets in conventional spot and forward foreign exchange contracts. In addition, some indirect evidence supports anecdotal reports that intermediation in volatility-related products (e.g., options contracts) has been a significantly profitable activity. Finally, on average, positions in currencies do not appear to contribute to profits. Tests applied to monthly and daily data on banks' portfolio positions suggest that banks cannot accurately forecast changes in exchange rates, and that these currency positions account for only a small fraction (if any) of the banks' foreign exchange earnings.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Financial Markets, Institutions and Money.

Volume (Year): 7 (1997)
Issue (Month): 1 (April)
Pages: 43-60

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Handle: RePEc:eee:intfin:v:7:y:1997:i:1:p:43-60

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Web page: http://www.elsevier.com/locate/intfin

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  12. Jaffe, Jeffrey F, 1974. "Special Information and Insider Trading," The Journal of Business, University of Chicago Press, vol. 47(3), pages 410-28, July.
  13. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-53, March.
  14. Marshall Blume & Robert Stambaugh, . "Biases in Computed Returns: An Application to the Size Effect (Revision of 2-83)," Rodney L. White Center for Financial Research Working Papers 11-83, Wharton School Rodney L. White Center for Financial Research.
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  16. Givoly, Dan & Palmon, Dan, 1985. "Insider Trading and the Exploitation of Inside Information: Some Empirical Evidence," The Journal of Business, University of Chicago Press, vol. 58(1), pages 69-87, January.
  17. Blume, Marshall E. & Stambaugh, Robert F., 1983. "Biases in computed returns : An application to the size effect," Journal of Financial Economics, Elsevier, vol. 12(3), pages 387-404, November.
  18. Finnerty, Joseph E, 1976. "Insiders and Market Efficiency," Journal of Finance, American Finance Association, vol. 31(4), pages 1141-48, September.
  19. Ritter, Jay R, 1988. " The Buying and Selling Behavior of Individual Investors at the Turn of the Year," Journal of Finance, American Finance Association, vol. 43(3), pages 701-17, July.
  20. Szakmary, Andrew C. & Mathur, Ike, 1997. "Central bank intervention and trading rule profits in foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 16(4), pages 513-535, August.
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  22. Michael P. Leahy, 1994. "Bank positions and forecasts of exchange rate movements," International Finance Discussion Papers 486, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Michael P. Leahy, 1994. "Bank positions and forecasts of exchange rate movements," International Finance Discussion Papers 486, Board of Governors of the Federal Reserve System (U.S.).
  2. Benassy-Quere, A. & Larribeau, S. & MacDonald, R., 1999. "Models of Exchange Rate Expectations: Heterogeneous Evidence from Panel Data," Papers 99-02, Paris X - Nanterre, U.F.R. de Sc. Ec. Gest. Maths Infor..
  3. Benassy-Quere, Agnes & Larribeau, Sophie & MacDonald, Ronald, 2003. "Models of exchange rate expectations: how much heterogeneity?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 13(2), pages 113-136, April.
  4. Alogoskoufis, George & Portes, Richard & Rey, Hélène, 1997. "The Emergence of the Euro as an International Currency," CEPR Discussion Papers 1741, C.E.P.R. Discussion Papers.
  5. Mende, Alexander & Menkhoff, Lukas, 2006. "Profits and Speculation in Intra-Day Foreign Exchange Trading," Hannover Economic Papers (HEP) dp-339, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  6. Sandra L. Chamberlain & John S. Howe & Helen Popper, 1996. "The Exchange Rate Exposure of U.S. and Japanese Banking Institutions," Center for Financial Institutions Working Papers 96-55, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Adrian E. Tschoegl, . "The Key to Risk Management: Management," Center for Financial Institutions Working Papers 99-42, Wharton School Center for Financial Institutions, University of Pennsylvania.

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