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Forex in the Future

Campbell R. Harvey
Duke University, Durham, NC USA
National Bureau of Economic Research, Cambridge MA USA

http://www.duke.edu/~charvey
Global Asset Allocation and Stock Selection
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Forex in the Future:
-----Current landscape
Market
$1.500 trillion in forex transacted every day*

$0.020 trillion stocks transacted on NYSE

*Does not include forwards, swaps, and options!

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Forex in the Future:
-----Current landscape
Trading
Basic technology has not changed in decades
(request for quote method)

Phone around to banks/investment banks and
get a quotation
Take the best price

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Forex in the Future:
-----Trading cost
Components
Clearing fee (say on 1 million ) $9-25
Bid-ask spread largest component
90% of the time 2-5 pips ($200-500)
median is 5 pips

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Forex in the Future:
-----Trading cost
0
5
10
15
20
25
30
35
40
45
50
0 1 2 3 4 5 6 7 8 9 10 11
Spread in pips for EUR-USD
Frequency in %
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Forex in the Future:
-----Trading cost
Why are trading costs so high?
Banks provide:
Clearing
Credit monitoring
Bear inventory risk
Plus, they make a pile of money!


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Forex in the Future:
-----New forces in the market
Two consoritia: FXall and Atriax
Similar product, different partners
Using the Internet, press a button and get the
best two way quote (bid-ask) from consortia
members
FXall has been around one year
Atriax launched in July 2001

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Forex in the Future:
-----New forces in the market
Two consoritia: FXall and Atriax
Advantages:
Saves time in doing phone around
Electronic execution


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Forex in the Future:
-----New forces in the market
Two consoritia: FXall and Atriax
Disadvantages:
Does not necessarily reduce spread cost
Makes collusion among consortium partners a
possibility (current DOJ investigation)
No cross quotes between the two consortia


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Forex in the Future:
-----New forces in the market
Two consoritia: FXall and Atriax
Disadvantages:
Generally, it is a bad business idea to request a
quote from a consortium you are asking for
trouble.
Overall, it is the same old market facilitated with
the Internet


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Forex in the Future:
-----New forces in the market
One consoritia:
Atriax goes out of business in 2002


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Forex in the Future:
-----New forces in the market
Others: Currenex
Advantages:
Independence


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Forex in the Future:
-----New forces in the market
Others: Currenex
Disadvantages:
Must take bid or ask
Does not accommodate a limit order book (like
NASDAQ trading)


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Forex in the Future:
-----New forces in the market
Others: Currenex?
London, Jan. 16, 2003 (Bloomberg) -- Currenex Inc.
Chief Executive Lori Mirek left the electronic
currency-trading company, Financial News said,
citing no one.
Mirek departed after at least three other
executives left in recent months, the weekly
financial newspaper reported on its Web site.
Mirek previously worked at America Online Inc. and
Netscape Communications Corp.
Rochel Velasco, a spokeswoman for Currenex,
said the companyhad no immediate comment.

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Forex in the Future:
-----New forces in the market
Reverse auction
Forexster.com
Applied for several patents for a reverse
auction type of system for FX trading
Two types of systems
Type 1 client communicating to many banks
Type 2 many clients communicating with bank


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Client Forexster
Bank 2
Bank 3
Bank 4
Bank 5
Bank 1
Type 1 unit
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Client Forexster
Bank 2
Bank 3
Bank 4
Bank 5
Bank 1
Reverse auction
Type 1 unit
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Client 2
Client 3
Client 4
Client 5
Client 6
Client 7
Client 8
Client 9
Client 1
Bank
Forexster
Type 2 unit
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Client 2
Client 3
Client 4
Client 5
Client 6
Client 7
Client 8
Client 9
Client 1
Bank
Forexster
D
i
r
e
c
t

t
r
a
d
e

Type 2 unit
20
Bank
Client
Type 1
Type 2
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25
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Forex in the Future:
-----New forces in the market
Further reading
Ben Wright, Unlocking the C2C forex riddle
Euromoney.com July 2001
Jennifer Morris Forex goes into future shock Euromoney
October 2001
Joff Wild Europe lags US in business-method patents
Euromoney March 2002
Tessa Oakley Forexster throws down client-to-client patent
challenge Euromoney March 2002