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

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  • John Ammer
  • Allan D. Brunner

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.

Suggested Citation

  • John Ammer & Allan D. Brunner, 1994. "Are banks market timers or market makers? Explaining foreign exchange trading profits," International Finance Discussion Papers 484, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:484
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    References listed on IDEAS

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    Cited by:

    1. Richard Portes & Hélène Rey, 1998. "The emergence of the euro as an international currency," Economic Policy, CEPR;CES;MSH, pages 305-343.
    2. Adrian E. Tschoegl, 2000. "The Key to Risk Management: Management," Center for Financial Institutions Working Papers 99-42, Wharton School Center for Financial Institutions, University of Pennsylvania.
    3. 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..
    4. 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.).
    5. 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, pages 113-136.
    6. Mende, Alexander & Menkhoff, Lukas, 2006. "Profits and speculation in intra-day foreign exchange trading," Journal of Financial Markets, Elsevier, vol. 9(3), pages 223-245, August.
    7. Narayan, Paresh Kumar & Mishra, Sagarika & Narayan, Seema & Thuraisamy, Kannan, 2015. "Is Exchange Rate Trading Profitable?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 38(C), pages 217-229.
    8. Chamberlain, Sandra & Howe, John S. & Popper, Helen, 1997. "The exchange rate exposure of U.S. and Japanese banking institutions," Journal of Banking & Finance, Elsevier, vol. 21(6), pages 871-892, June.
    9. Boschen, John F. & Smith, Kimberly J., 2016. "The uncovered interest rate parity anomaly and trading activity by non-dealer financial firms," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 333-342.

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    Keywords

    Bank profits ; Foreign exchange;

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