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Anticipations of Foreign Exchange Volatility and Bid-Ask Spreads

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  • Shang-Jin Wei

Abstract

The paper studies the effect of the market's perceived exchange rate volatility on bid-ask spreads. The anticipated volatility is extracted from currency options data. An increase in the perceived volatility is found to widen bid-ask spreads. The direction of the effect is consistent with an option model of the spread, but the magnitude is smaller. An increase in trading volume of spot exchange rates also widens the spread. The omission of the trading volume, however, does not bias the estimate of the effect of the volatility on the spreads. Although the spread-volatility relation implied by the option model of the spread is close to linear, some form of nonlinearity can still be detected from the data.

Suggested Citation

  • Shang-Jin Wei, 1994. "Anticipations of Foreign Exchange Volatility and Bid-Ask Spreads," NBER Working Papers 4737, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:4737
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    Cited by:

    1. Jeffrey A. Frankel & Andrew K. Rose, 1994. "A Survey of Empirical Research on Nominal Exchange Rates," NBER Working Papers 4865, National Bureau of Economic Research, Inc.
    2. Mende, Alexander, 2005. "09/11 on the USD/EUR Foreign Exchange Market," Hannover Economic Papers (HEP) dp-312, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
    3. Detken, Carsten & Hartmann, Philipp, 2000. "The Euro and International Capital Markets," International Finance, Wiley Blackwell, vol. 3(1), pages 53-94, April.
    4. Mr. Torbjorn I. Becker & Mr. Amadou N Sy, 2005. "Were Bid-Ask Spreads in the Foreign Exchange Market Excessive During the Asian Crisis?," IMF Working Papers 2005/034, International Monetary Fund.
    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. Parsley, David C & Wei, Shang-Jin, 1993. "Insignificant and Inconsequential Hysteresis: The Case of U.S. Bilateral Trade," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 606-613, November.
    7. Geir H. Bjønnes & Dagfinn Rime & Haakon O. Aa. Solheim, 2002. "Volume and Volatility in the FX-Market: Does it matter who you are?," CESifo Working Paper Series 786, CESifo.
    8. Hartmann, Philipp, 1998. "Do Reuters spreads reflect currencies' differences in global trading activity?," Journal of International Money and Finance, Elsevier, vol. 17(5), pages 757-784, October.
    9. Jeffrey A. Frankel & Giampaolo Galli & Alberto Giovannini, 1996. "Introduction to "The Microstructure of Foreign Exchange Markets"," NBER Chapters, in: The Microstructure of Foreign Exchange Markets, pages 1-18, National Bureau of Economic Research, Inc.
    10. Gabriele Galati, 2000. "Trading volumes, volatility and spreads in foreign exchange markets: evidence from emerging market countries," BIS Working Papers 93, Bank for International Settlements.
    11. Shang-Jin Wei & Jeffrey A. Frankel, 1991. "Are Option-Implied Forecasts of Exchange Rate Volatility Excessively Variable?," NBER Working Papers 3910, National Bureau of Economic Research, Inc.
    12. Carsten Detken & Philipp Hartmann, 2000. "The Euro and International Capital Markets," International Finance, Wiley Blackwell, vol. 3(1), pages 53-94, April.
    13. Hua, Mingshu, 2009. "A study on foreign exchange dealers' bid-ask spread quote behavior," Pacific-Basin Finance Journal, Elsevier, vol. 17(4), pages 506-523, September.

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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