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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

Trading

Basic technology has not changed in decades

(“request for quote” method)

• 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

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101520253035404550

0 1 2 3 4 5 6 7 8 9 10 11

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

Two consoritia: FXall and Atriax

Advantages:

• 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 Atriax

Disadvantages:

• Does not necessarily reduce spread cost

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

• No cross quotes between the two consortia

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

Two consoritia: FXall and Atriax

Disadvantages:

Generally, it is a bad business idea to request a quote from a consortium – you are asking for trouble.

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

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

One consoritia:

Atriax goes out of business in 2002

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

Others: Currenex

Advantages:

• Independence

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

Others: Currenex

Disadvantages:

• Must take bid or ask

• Does not accommodate a limit order book (like NASDAQ trading)

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

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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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

Dir

ect t

rade

Type 2 unit

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Bank

Client

Type 1

Type 2

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25

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

Further reading• Ben Wright, “Unlocking the C2C forex riddle”

Euromoney.com July 2001

• Jennifer Morris “Forex goes into future shock” Euromoney October 2001

• Joff Wild “Europe lags US in business-method patents” Euromoney March 2002

• Tessa Oakley “Forexster throws down client-to-client patent challenge” Euromoney March 2002