Microstructure of Foreign Exchange Markets

An overview of research on the microstructure of foreign exchange (FX) markets is presented. We begin by summarizing the institutional features of FX trading and describe how they have evolved since the 1980s. We then explain how these features are represented in microstructure models of FX trading. Next, we describe the links between microstructure and traditional macro exchange-rate models and summarize how these links have been explored in recent empirical research. Finally, we provide a microstructure perspective on two recent areas of interest in exchange-rate economics: the behavior of returns on currency portfolios, and questions of competition and regulation.

Network analysis and systemic FX settlement risk

A proposal for applying network analysis to a foreign exchange (FX) settlement system is considered. In particular, network centrality metrics are used to analyse payments of financial institutions which settle through CLS Bank (CLS). Network centrality metrics provide a way to study settlement members’ connectivity, obtain a sense of their payments evolution with time, and measure their network topology variability. The analysis shows that although the continuous link settlement (CLS) network structure can be approximated with a power law degree distribution for many trade days, this is not always the case. A network community detection algorithm is applied to the FX settlement network to explore relationships between communities and to detect classification patterns in the FX trading net payments. A metric called SinkRank is used to build a ranking of the most systemic settlement risk important financial institutions trading on the FX system, and to understand how the metric depends on network’s connectivity. Since network metrics do not fully explain the dynamics of the settlement process, the CLS’ settlement system is simulated to measure the contagion of unsettled trades and its spread among network members. The effect of settlement failure and contagion on the settlement members is also explored.

The Effect of NPS‘s FX Trading on Exchange Rate

In June 2014, the asset under management of National Pension Service (NPS) of Korea reached over 444 trillion won. NPS forecasts that the asset size will gradually grow to around 2,561 trillion won until 2043. The NPS investment of domestic equities and fixed income securities have been already saturated. So the NPS started to expand in global investment. Accordingly, the worries have grown that NPS's trading in foreign exchange markets may lead to the instability in FX markets. This study has analyzed the influence of NPS's foreign exchange transactions in domestic FX market. The period of study was 54 months from Jan 2010 to June 2014. For detailed research, separate analysis was performed by full year and each year. Our main findings can be summarized as follows : There are statistically plus significant influences of the NPS’s trading volume on the estimated volatility of spot rate on the first half. However, there are minus significant influences on the second half. The NPS's FX trading is known to be systematically regulated by the financial planning of the investment committee. The result of this study shows that the regulation of the NPS’s FX trading minimizes the disturbances of the currency by maintaining the stable market expectation in FX markets.