Working Paper: NBER ID: w4737
Authors: Shangjin 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.
Keywords: Foreign Exchange; Volatility; Bid-Ask Spreads; Options Pricing
JEL Codes: F31; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market's perceived exchange rate volatility (F31) | widening of bid-ask spread (G19) |
| trading volume (G15) | widening of bid-ask spread (G19) |
| market's perceived exchange rate volatility (F31) | trading volume (G15) |