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Anticipations of Foreign Exchange Volatility and Bid-Ask Spreads
Shang-Jin Wei
Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); International Monetary Fund (IMF); Tsinghua University - School of Economics & Management
May 1994
NBER Working Paper No. w4737
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.
Number of Pages in PDF File: 43
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Date posted: November 24, 2000
Suggested CitationWei, Shang-Jin, Anticipations of Foreign Exchange Volatility and Bid-Ask Spreads (May 1994). NBER Working Paper No. w4737. Available at SSRN: http://ssrn.com/abstract=250347
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