How do UK‐based foreign exchange dealers think their market operates?

TLDR

The study surveys UK-based foreign exchange dealers in 1998 to investigate their market views. The survey examines three areas: the microeconomic operation of the FX market, dealers’ beliefs about macroeconomic fundamentals, and FX microstructure factors. The results show heterogeneous dealer beliefs that cannot be explained by institutional characteristics, with non‑observable fundamentals dominating short‑term rate moves, observable fundamentals influencing even shorter horizons, and market norms and behavioral factors strongly shaping bid‑ask spreads. © 2004 John Wiley & Sons, Ltd.

Abstract

Abstract This paper summarizes the results of a survey of UK‐based foreign exchange dealers conducted in 1998. It addresses topics in three main areas: the microeconomic operation of the foreign exchange market; the beliefs of dealers regarding the importance, or otherwise, of observable macroeconomic fundamental factors in affecting exchange rates; microstructure factors in FX. We find that heterogeneity of traders' beliefs is evident from the results but that it is not possible to explain such disagreements in terms of institutional detail, rank or trading technique (e.g. technical analysts versus fundamentalists). As expected, non‐observable fundamental factors are thought to dominate short horizon changes in exchange rates, but observable fundamentals are deemed important over much shorter horizons than the mainstream empirical literature would suggest. Finally, market ‘norms’ and behavioural phenomena are very strong in the FX market and appear to be key determinants of the bid–ask spread. Copyright © 2004 John Wiley & Sons, Ltd.