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Forex in the Future

Campbell R. HarveyDuke University, Durham, NC USA

National Bureau of Economic Research, Cambridge MA USA

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

Global Asset Allocation and Stock Selection

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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

TradingBasic 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

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

05

101520253035404550

0 1 2 3 4 5 6 7 8 9 10 11Spread in pips for EUR-USD

Frequency in %

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

Why are trading costs so high?Banks provide:• Clearing• Credit monitoring• Bear inventory riskPlus, they make a pile of money!

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

Two consoritia: FXall and AtriaxSimilar 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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Forex in the Future:-----New forces in the market

Two consoritia: FXall and AtriaxAdvantages:• Saves time in doing phone around• Electronic execution

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

Two consoritia: FXall and AtriaxDisadvantages:• Does not necessarily reduce spread cost• Makes collusion among consortium partners a

possibility (current DOJ investigation)• No cross quotes between the two consortiaBasically, it is the same old market facilitated with

the Internet

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

Reverse auctionForexster.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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Client Forexster

Bank 2

Bank 3

Bank 4

Bank 5

Bank 1Type 1 unit

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Client Forexster

Bank 2

Bank 3

Bank 4

Bank 5

Bank 1

Reverse auction

Type 1 unit

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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

Dire

ct tr

adeType 2 unit

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Bank

Client

Type 1

Type 2

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

Further readingBen Wright, “Unlocking the C2C forex riddle”Euromoney on-line, July 25, 2001