1 Forex in the Future: Implications for Asset Management Campbell R. Harvey Duke University, Durham, NC USA National Bureau of Economic Research, Cambridge

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Forex in the Future: Implications for Asset Management

Campbell R. HarveyDuke University, Durham, NC USA

National Bureau of Economic Research, Cambridge MA USA

http://www.duke.edu/~charvey

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Forex in the Future:-----Current landscape

Market

$1.500 trillion in forex transacted every day*

$0.020 trillion stocks transacted on NYSE

*Does not include forwards, swaps, and options!

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Forex in the Future:-----Current landscape

Trading

Basic technology has not changed in decades

• Phone around to banks/investment banks and get a quotation

• Take the best price

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Forex in the Future:-----Trading technology

Trading

Basic technology has not changed in decades

• Phone around to banks/investment banks and get a quotation

• Take the best price

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Forex in the Future:-----Trading cost

Components

• Clearing fee (say on 1 million €) $9-25

• Bid-ask spread largest component– 90% of the time 2-5 pips ($200-500)– median is 5 pips

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0%5%

10%15%20%25%30%35%40%45%50%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for EUR-USD

Frequency in %

one pip is 100 USD

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0%

5%

10%

15%

20%

25%

30%

35%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for USD-JPY

Frequency one pip is 10000 JPY (about $80)

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0%5%

10%15%20%25%30%35%40%45%50%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for USD-CAD

Frequency one pip is 100 CAD (about $65)

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0%5%

10%15%20%25%30%35%40%45%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for USD-CHF

Frequency one pip is 100 CHF (about $60)

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0%

5%

10%

15%

20%

25%

30%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for GBP-USD

Frequency one pip is 100 USD

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0%5%

10%15%20%25%30%35%40%45%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for USD-CHF


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0%

5%

10%

15%

20%

25%

30%

35%

40%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for EUR-JPY

Frequency one pip is 10000 JPY (about $80)

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0%

5%

10%

15%

20%

25%

30%

35%

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Spread in pips for EUR-CHF


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Why are trading costs so high?

Banks provide:

• Clearing

• Credit monitoring

• Bear inventory risk

Plus, they make a pile of money!

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Forex in the Future:-----New forces in the market

Two consoritia: FXall and Atriax

Similar product, different partners

• Using the Internet, press a button and get the best two way quote (bid-ask) from consortia members

• FXall has been around one year

• Atriax launched in July 2001

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Advantages:

• Saves time in doing phone around

• Electronic execution

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Disadvantages:

• Does not necessarily reduce spread cost

• Makes collusion among consortium partners a possibility (current DOJ investigation)

• No cross quotes between the two consortia

Basically, it is the same old market facilitated with the Internet

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Reverse auction

Forexster.com

• Applied for several patents for a reverse auction type of system for FX trading

• Two types of systems– Type 1 client communicating to many banks– Type 2 many clients communicating with bank

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ClientForexster

Bank 2

Bank 3

Bank 4

Bank 5

Bank 1Type 1 unit

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Client

Bank 2

Bank 3

Bank 4

Bank 5

Bank 1

Reverse auction

Type 1 unit

Forexster

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Client 2

Client 3

Client 4

Client 5

Client 6

Client 7

Client 8

Client 9

Client 1

BankForexster

Type 2 unit

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Client 2

Client 3

Client 4

Client 5

Client 6

Client 7

Client 8

Client 9

Client 1

BankForexster

Dir

ect t

rade

Type 2 unit

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Bank

Client

Type 1

Type 2

Direct trade

FXLine

Interconnected Type 1 and Type 2 units

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Further reading

Ben Wright, “Unlocking the C2C forex riddle”

Euromoney on-line, July 25, 2001

Documents

1 Forex in the Future: Implications for Asset Management Campbell R. Harvey Duke University, Durham, NC USA National Bureau of Economic Research, Cambridge