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What determines transaction costs in foreign exchange markets?

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  • Tarun Ramadorai

    (University of Oxford and CEPR, UK)

Abstract

Using detailed data on the currency transactions of institutional fund managers, this paper shows that funds that experience high returns on their currency holdings also incur lower transaction costs on their currency trades. This finding holds both in the cross section, i.e. funds that perform better on average incur lower average transaction costs, as well as in time series, i.e. funds that do better over the past two months incur lower transaction costs on subsequent transactions. The results are consistent with foreign exchange dealers bidding for information from successful traders. They are also consistent with foreign exchange dealers exploiting price inelastic demand for foreign currency trades, or funds acting as secondary liquidity providers in foreign exchange markets. The paper also investigates the role of fund size, transaction frequency and return volatility on transactions costs. Copyright © 2007 John Wiley & Sons, Ltd.

Suggested Citation

  • Tarun Ramadorai, 2008. "What determines transaction costs in foreign exchange markets?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(1), pages 14-25.
    • Handle: RePEc:ijf:ijfiec:v:13:y:2008:i:1:p:14-25
    DOI: 10.1002/ijfe.351
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    Cited by:

    1. Osler, Carol & Savaser, Tanseli, 2022. "Shrouding and the FX trades of global custody bank," Journal of Banking & Finance, Elsevier, vol. 136(C).
    2. Cui, Zhenyu & Taylor, Stephen, 2020. "Arbitrage detection using max plus product iteration on foreign exchange rate graphs," Finance Research Letters, Elsevier, vol. 35(C).
    3. Osler, Carol L. & Mende, Alexander & Menkhoff, Lukas, 2011. "Price discovery in currency markets," Journal of International Money and Finance, Elsevier, vol. 30(8), pages 1696-1718.
    4. Menkhoff, Lukas & Schmeling, Maik, 2010. "Trader see, trader do: How do (small) FX traders react to large counterparties' trades?," Journal of International Money and Finance, Elsevier, vol. 29(7), pages 1283-1302, November.
    5. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.
    6. Bent Jesper Christensen & Rasmus Tangsgaard Varneskov, 2021. "Dynamic Global Currency Hedging [Arbitrage in the Foreign Exchange Market: Turning on the Microscope]," The Journal of Financial Econometrics, Society for Financial Econometrics, vol. 19(1), pages 97-127.
    7. Carol Osler & Thang Nguyen & Tanseli Savaser, 2011. "Asymmetric Information and the Foreign-Exchange Trades of Global Custody Banks," Department of Economics Working Papers 2011-09, Department of Economics, Williams College.
    8. Tajaddini, Reza & Crack, Timothy Falcon, 2012. "Do momentum-based trading strategies work in emerging currency markets?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(3), pages 521-537.
    9. Hsu, Po-Hsuan & Taylor, Mark P, 2014. "Forty Years, Thirty Currencies and 21,000 Trading Rules: A Large-scale, Data-Snooping Robust Analysis of Technical Trading in the Foreign Exchange Market," CEPR Discussion Papers 10018, C.E.P.R. Discussion Papers.
    10. Menkhoff, Lukas & Osler, Carol L. & Schmeling, Maik, 2010. "Limit-order submission strategies under asymmetric information," Journal of Banking & Finance, Elsevier, vol. 34(11), pages 2665-2677, November.
    11. Nicholas Wilson, 2011. "Fertility Responses to Prevention of Mother-to-Child Transmission of HIV," Center for Development Economics 2011-08, Department of Economics, Williams College, revised Sep 2011.
    12. Melvin, Michael & Prins, John & Shand, Duncan, 2013. "Forecasting Exchange Rates: an Investor Perspective," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 721-750, Elsevier.
    13. Hasbrouck, Joel & Levich, Richard M., 2021. "Network structure and pricing in the FX market," Journal of Financial Economics, Elsevier, vol. 141(2), pages 705-729.
    14. Geir H. Bjønnes & Carol L. Osler & Dagfinn Rime, 2009. "Asymmetric information in the interbank foreign exchange market," Working Paper 2008/25, Norges Bank.
    15. Michael R. King & Carol Osler & Dagfinn Rime, 2011. "Foreign exchange market structure, players and evolution," Working Paper 2011/10, Norges Bank.
    16. Pintér, Gábor & Wang, Chaojun & Zou, Junyuan, 2022. "Information chasing versus adverse selection," Bank of England working papers 971, Bank of England.
    17. Hsu, Po-Hsuan & Taylor, Mark P. & Wang, Zigan, 2016. "Technical trading: Is it still beating the foreign exchange market?," Journal of International Economics, Elsevier, vol. 102(C), pages 188-208.
    18. Carol Osler & Xuhang Wang, 2012. "The Microstructure of Currency Markets," Working Papers 49, Brandeis University, Department of Economics and International Businesss School.

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