Analysis of Spreads in the Dollar/Euro and Deutsche Mark/Dollar Foreign Exchange Markets

Posted: 14 Jun 2007

See all articles by Charles Goodhart

Charles Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group

Ryan Love

London School of Economics & Political Science (LSE)

Richard Payne

City University London - The Business School

Dagfinn Rime

BI Norwegian Business School

Abstract

We compute bid-ask spreads for the dollar/euro exchange rate and find them to be substantially larger than their deutschemark counterparts before introduction of the euro. We show that larger percentage spreads are not explained by volatility, trade intensity, and other standard explanatory variables in our data sets. But we also show that spreads have not increased in terms of the unit ('pip') used in exchange rate quotations to the fourth decimal point. Since the euro is worth about two marks, and was initially worth more than a dollar, this finding suggests that larger percentage spreads reflect the more pronounced 'granularity' of quoting conventions in euro-dollar rather than dollar-mark trading. We discuss whether mandating quotations to the fifth decimal might be advisable, and conclude that such a policy might, but need not, increase the foreign exchange market's liquidity.

Suggested Citation

Goodhart, Charles A.E. and Love, Ryan and Payne, Richard G. and Rime, Dagfinn, Analysis of Spreads in the Dollar/Euro and Deutsche Mark/Dollar Foreign Exchange Markets. Economic Policy, Vol. 17, No. 35, 2002, Available at SSRN: https://ssrn.com/abstract=991770

Charles A.E. Goodhart

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
0207 955 7555 (Phone)
0207 242 1006 (Fax)

Ryan Love

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Richard G. Payne

City University London - The Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Dagfinn Rime (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway
+47-46410507 (Phone)

HOME PAGE: http://home.bi.no/dagfinn.rime/

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