Forex in the Future Campbell R. Harvey Global Asset Allocation and Stock Selection 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

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!

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

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

Forex in the Future: -----Trading cost Frequency in %

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!

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

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

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

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

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

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

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)

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

Type 1 unit Bank 1 Bank 2 Client Forexster Bank 3 Bank 4 Bank 5

Type 1 unit Bank 1 Reverse auction Bank 2 Client Forexster Bank 3

Type 2 unit Client 1 Client 2 Client 3 Client 4 Forexster Bank

Type 2 unit Client 1 Client 2 Client 3 Client 4 Direct trade Forexster Bank Client 6 Client 7 Client 8 Client 9

Type 2 Type 1 Bank Client

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