Bid-ask spread dynamics in foreign exchange markets

Patricia L. Chelley-Steeley*, Nikolaos Tsorakidis

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

The aim of this paper is to examine the short term dynamics of foreign exchange rate spreads. Using a vector autoregressive model (VAR) we show that most of the variation in the spread comes from the long run dependencies between past and future spreads rather than being caused by changes in inventory, adverse selection, cost of carry or order processing costs. We apply the Integrated Cumulative Sum of Squares (ICSS) algorithm of Inclan and Tiao (1994) to discover how often spread volatility changes. We find that spread volatility shifts are relatively uncommon and shifts in one currency spread tend not to spillover to other currency spreads.

Original languageEnglish
Pages (from-to)119-131
Number of pages13
JournalInternational Review of Financial Analysis
Volume29
Early online date20 Mar 2013
DOIs
Publication statusPublished - Sep 2013

Keywords

  • bid-ask spreads
  • exchange rate
  • microstructure costs

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