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The Euro as an International Currency: Explaining Puzzling First Evidence

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  • Hau, Harald
  • Killeen, William
  • Moore, Michael J

Abstract

This paper presents evidence that the bid-ask spreads in euro rates increased relative to the corresponding bid-ask spreads in the German mark (DM) prior to the currency union. This comes with a decrease in transaction volume in the euro rates relative to the previous DM rates. The starkest example is the DM(euro)/yen rate in which the spread has risen by almost two-thirds while the volume has almost halved. We propose a microstructure theory for a system of multiple exchange rates in which spreads are endogenously determined. It is argued that the elimination of cross rates due to the introduction of the euro reduced the intra-temporal risk sharing capacity of the multicurrency dealership market. A second explanation for the increase in the euro bid-ask spreads and the relative euro volume loss is based on an increase in the information content of order flow in euro rates relative to previous DM rates.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2510.

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Date of creation: Jul 2000
Date of revision:
Handle: RePEc:cpr:ceprdp:2510

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Related research

Keywords: Microstructure; Spreads; Transaction Costs; Vehicle Currency;

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Citations

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Cited by:
  1. McGroarty, Frank & ap Gwilym, Owain & Thomas, Stephen, 2006. "Microstructure effects, bid-ask spreads and volatility in the spot foreign exchange market pre and post-EMU," Global Finance Journal, Elsevier, vol. 17(1), pages 23-49, September.
  2. William P. Killeen & Richard K. Lyons & Michael J. Moore, 2001. "Fixed versus Flexible: Lessons from EMS Order Flow," NBER Working Papers 8491, National Bureau of Economic Research, Inc.
  3. Papaioannou, Elias & Portes, Richard & Siourounis, Gregorios, 2006. "Optimal currency shares in international reserves: The impact of the euro and the prospects for the dollar," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 508-547, December.
  4. Kaul, Aditya & Sapp, Stephen, 2006. "Y2K fears and safe haven trading of the U.S. dollar," Journal of International Money and Finance, Elsevier, vol. 25(5), pages 760-779, August.
  5. Heimonen, Kari, 2001. "Substituting a Substitute Currency – The Case of Estonia," BOFIT Discussion Papers 11/2001, Bank of Finland, Institute for Economies in Transition.
  6. Charles Goodhart & Ryan Love & Richard Payne & Dagfinn Rime, 2002. "Analysis of spreads in the dollar/euro and Deutsche Mark/dollar foreign exchange markets," LSE Research Online Documents on Economics 24958, London School of Economics and Political Science, LSE Library.
  7. Jorge Iván Canales Kriljenko, 2004. "Foreign Exchange Market Organization in Selected Developing and Transition Economies," IMF Working Papers 04/4, International Monetary Fund.
  8. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements.
  9. Portes, Richard, 2001. "The Euro and the International Financial System," CEPR Discussion Papers 2955, C.E.P.R. Discussion Papers.
  10. Andreas M. Fischer, 2002. "Fluctuations in the Swiss Franc: What has Changed Since the Euro's Introduction?," Working Papers 02.03, Swiss National Bank, Study Center Gerzensee.

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