Publications and working papers

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Refereed publications

1. "Exchange Rate Forecasting, Order Flow and Macroeconomic Information" (with Lucio Sarno and Elvira Sojli), Journal of International Economics, vol. 80, issue 1 (January 2010), pp. 72-88.
   
2. "Does the law of one price hold in international financial markets? Evidence from tick data", (with Farooq Akram and Lucio Sarno), Journal of Banking and Finance, vol. 33, issue 10, pp. 1741-1754.
   
3. "Arbitrage in the Foreign Exchange Market: Turning on the Microscope", (with Q. Farooq Akram and Lucio Sarno), Journal of International Economics, vol. 76, (November 2008), pp. 237-253. VOX-entry
   
4. "Exchange Rate Volatility and the Mixture of Distribution Hypothesis", (with Luc Bauwens and Genaro Sucarrat), Empirical Economics, (October 2005), pp. 1-23.
   
5. "Liquidity provision in the overnight foreign exchange market", (with Geir H. Bjønnes and Haakon O.Aa. Solheim), Journal of International Money and Finance, vol. 24, issue 2 (March 2005), pp. 177-198.
    
6. "Dealer Behavior and Trading Systems in the Foreign Exchange Market", (with Geir H. Bjønnes), Journal of Financial Economics, vol. 75, issue 3 (March 2005), pp. 571-605.
    
7. "Volume and Volatility in the FX Market: Does it matter who you are?", (with Geir H. Bjønnes and Haakon O.Aa. Solheim), in Exchange Rate Economics: Where do we Stand? (Paul De Grauwe, ed.), MIT Press, 2005.  
   
8. "New Electronic Trading Systems in the Foreign Exchange Market" in New Economy Handbook (Derek C. Jones, ed.), Academic Press, 2003.
   
9. "Analysis of spreads in the Dollar/Euro and Deutsche Mark/Dollar foreign exchange markets", (with Charles Goodhart, Ryan Love and Richard Payne), Economic Policy, vol. 17, issue 35 (October 2002), pp. 536-552.
   

Other publications

1. "Order flow analysis of exchange rates"
   (with Elvira Sojli), in NB Economic Bulletin, no. 3 (2006)
   English version
   Norwegian version (Penger og Kreditt, no. 2, 2006)
2. "The Tobin tax: Perspectives from microstructure finance" (in Norwegian), (with Dag Henning Jacobsen), in Økonomisk Forum, no. 5 (2005)
3. "Electronic FX Trading -- influencing dealer behaviour?", (with Geir H. Bjønnes), in e-FOREX, (July, 2004).
    Document
4. "The Role of Foreign Speculators in Speculative Attacks: The Case of 1998", (with Geir H. Bjønnes and Haakon O.Aa. Solheim), in Recent Developments on Exchange Rates (Sandrine Lardic and Valérie Mignon, eds.), Palgrave, 2004.
5. "What can financial economics teach us about exchange rates?", in Explaining movements in the Norwegian exchange rate (Øyvind Eitrheim and Kristin Gulbrandsen, eds.), Occasional Papers, no. 32, Norges Bank, 2004.
   English version
   Norwegian version (Occasional Papers, no. 31, 2003)
6. "Sand in the machinery, or in the eyes of the Tobin-tax proponents?" (in Norwegian), (with Dag Henning Jacobsen), in Vill valuta. en debattbok om tobinskatten (Nina Drange and Linn Stalsberg, eds.), ATTAC Norway, 2002.
7. Trading in Foreign Exchange Markets: Four Essays on the Market Microstructure of Foreign Exchange Markets, Series of Ph.D. Dissertations, No. 2, Norwegian School of Management BI, 2001.

Working Papers

1. "Asymmetric Information in the Foreign Exchange Interdealer Market"
   (with Geir H. Bjønnes and Carol Osler), Norges Bank Working Paper 2008/25.
    
2. "'Large' vs. 'Small' Players: A Closer Look on the Dynamics of Speculative Attacks", (with Geir H. Bjønnes, Steinar Holden and Haakon O. Aa. Solheim), October 2005.
    Norges Bank Working Paper (2005/13)
    Updated March 2007
3. "U.S. Exchange Rates and Currency Flows", Working Paper 4, Stockholm Institute for Financial Research, 2001.
4. "Customer Trading and Information in Foreign Exchange Market", (with Geir H. Bjønnes), Memorandum 30/2000, Department of Economics, University of Oslo.
5. "Private or Public Information in the Foreign Exchange Markets? An Empirical Analysis", Memorandum 14/2000, Department of Economics, University of Oslo.

Work in progress

1. "A Transaction Data Study of The Forward Bias Puzzle" (with Francis Breedon and Paolo Vitale), December 2009.
2. "Forecasting the Foreign Exchange Market Using Private Information" (with Anna Lindahl), November 2006.
3. "Euro transaction costs: Rents or (il)liquidity compensation?"
   (with Michael Moore), February 2006.
4. "Order Flow and Exchange Rates: Liquidity or Information effects?"
   (with Lucio Sarno and Elvira Sojli), February 2006.
5. "Exchange Rate Volatility and Heterogeneity"
   (with Genaro Sucarrat), November 2005.
6. "The Volume-Volatility relation and the influence by different players in the FX market"
   (with Geir H. Bjønnes, and Haakon O. Aa. Solheim), November 2004.

Abstracts

• "Arbitrage in the Foreign Exchange Market: Turning on the Microscope", (with Q. Farooq Akram and Lucio Sarno), Journal of International Economics, forthcoming.
  
  This paper provides real-time evidence on the frequency, size, duration and economic significance of arbitrage opportunities in the foreign exchange market. We investigate deviations from the covered interest rate parity (CIP) condition using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency. The analysis unveils that: i) short-lived violations of CIP arise; ii) the size of CIP violations can be economically significant; iii) their duration is, on average, high enough to allow agents to exploit them, but low enough to explain why such opportunities have gone undetected in
  much previous research using data at lower frequency.
  
  JEL classification: F31; F41; G14; G15.
  Keywords: exchange rates; arbitrage; covered interest rate parity; foreign exchange microstructure.
  
• "Exchange Rate Volatility and the Mixture of Distribution Hypothesis", (with Luc Bauwens and Genaro Sucarrat), Empirical Economics, (October 2005), pp. 1-23.
  
  This paper sheds new light on the mixture of distribution hypothesis by means of a study of the weekly exchange rate volatility of the Norwegian krone. In line with other studies we find that the impact of information arrival on exchange rate volatility is positive and statistically significant, and that the hypothesis that an increase in the number of traders reduces exchange rate volatility is not supported. The novelties of our study consist in documenting that the positive impact of information arrival on volatility is relatively stable across three different exchange rate regimes, and in that the impact is relatively similar for both weekly and weekly realised volatility. We also report a case in which undesirable residual properties attained within traditional frameworks are easily removed by applying the log-transformation on volatilities.
  
  Keywords: Exchange rate volatility, log-linear analysis, mixture of distribution hypothesis.
  JEL Classification Numbers: F31
• "Liquidity provision in the overnight foreign exchange market", (with Geir H. Bjønnes and Haakon O.Aa. Solheim), Journal of International Money and Finance, vol. 24, issue 2 (March 2005), pp. 177-198.
  
  We presents evidence that non-financial customers are the main liquidity providers in the overnight foreign exchange market using a unique daily data set covering almost all transactions in the SEK/EUR market over almost ten years. Two main findings support this: (i) The net position of non-financial customers is negatively correlated with the exchange rate, opposed to the positive correlation found for financial customers; (ii) Changes in net position of non-financial customers are forecasted by changes in net position of financial customers, indicating that non-financial customers take a passive role consistent with liquidity provision.
  
  Keywords: microstructure, international finance, liquidity.
  JEL Classification Numbers: F31, F41, G15.
• "Dealer Behavior and Trading Systems in the Foreign Exchange Market", (with Geir H. Bjønnes), Journal of Financial Economics, vol. 75, issue 3 (March 2005), pp. 571-605.
  
  We study dealer behavior in the foreign exchange spot market using detailed observations on all the transactions of four interbank dealers. There is strong support for an information effect in incoming trades. The direction of trade is most important, but we also find that the information effect increases with trade size in direct bilateral trades. All four dealers control their inventory intensively. Inventory control is not, however, manifested through a dealer's own prices in contrast to findings by Lyons [J. Fin. Econ 39(1995) 321]. Furthermore, we document differences in trading styles, especially how they actually control their inventories.
  
  Keywords: Foreign Exchange, Trading, Microstructure.
  JEL Classification Numbers: G15; F31; F33.
• "Volume and Volatility in the FX Market: Does it matter who you are?", (with Geir H. Bjønnes and Haakon O.Aa. Solheim), in Exchange Rate Economics: Where do we Stand? (Paul De Grauwe, ed.), MIT Press, 2005.
  
  The relationship between volume and volatility has received much attention in the literature on financial markets. However, due to the lack of data, few results have been presented for the foreign exchange (FX) market. Furthermore, most studies contain only aggregate series, and cannot distinguish between the impact of different participants or instruments. We study the impact of volume on volatility in the FX market using a unique data set of daily trading in the Swedish krona (SEK) market. The data set covers 95 percent of worldwide SEK trading, and is disaggregated on a number of reporting banks' buying and selling in five different instruments on a daily basis from 1995 until 2002. We find that volume in general show a positive correlation with volatility. However, the strength of the relationship depends on the instrument traded and the identity of the reporting bank. In particular, we find that trading tends to concentrate around the largest banks during periods of high volatility. These banks are probably also best informed. This is especially the case when volatility is high. We interpret this as evidence that heterogeneous expectations are important to an understanding of the volume-volatility relationship.
  
  Keywords: Volume-volatility relation, microstructure, exchange rates.
  JEL Classification Numbers: F31.
• "New Electronic Trading Systems in the Foreign Exchange Market" in New Economy Handbook (Derek C. Jones, ed.), Academic Press, 2003.
  
  The foreign exchange market can be divided in two segments: the interbank market and the customer market. Two recent advances in trading technology, electronic brokers in the interbank market and internet trading for customers, have significantly changed the structure of the foreign exchange market. In this paper we explain the functioning of electronic brokers and internet trading and discuss the economic consequences.
• "Analysis of spreads in the Dollar/Euro and Deutsche Mark/Dollar foreign exchange markets", (with Charles Goodhart, Ryan Love and Richard Payne), Economic Policy, vol. 17, issue 35 (October 2002), pp. 536-552.
  
  We compute bid-ask spreads for the dollar/euro exchange rate and find them to be substantially larger than their deutschemark counterparts before introduction of the euro. We show that larger percentage spreads are not explained by volatility, trade intensity, and other standard explanatory variables in our data sets. But we also show that spreads have not increased in terms of the unit ('pip') used in exchange rate quotations to the fourth decimal point. Since the euro is worth about two marks, and was initially worth more than a dollar, this finding suggests that larger percentage spreads reflect the more pronounced 'granularity' of quoting conventions in euro-dollar rather than dollar-mark trading. We discuss whether mandating quotations to the fifth decimal might be advisable, and conclude that such a policy might, but need not, increase the foreign exchange market's liquidity.
• "The Role of Foreign Speculators in Speculative Attacks: The Case of 1998", (with Geir H. Bjønnes and Haakon O.Aa. Solheim), in Recent Developments on Exchange Rates (Sandrine Lardic and Valérie Mignon, eds.), Palgrave, 2004.
  
  We empirically investigate two important issues in the literature on speculative attacks: the role of foreign speculators and the role of contagion between markets. During 1998 both Norway and Sweden experienced a speculative attack, despite having different monetary policy regimes and different economic outlook. The speculative attack can be related to international uncertainty following the debt crisis and the following moratorium issued by Russia in August 1998. We use three sets of explanatory variables: (i) Monetary policy reaction through interest rate setting; (ii) International risk as measured by the 10-year swap spread in the US market; and (iii) Changes in accumulated net holdings of local currency by foreign financial investors. Data on currency holdings are a unique feature of our investigation. We find that during the period of the speculative attack there was a close relationship between holdings of local currency by foreign financial investors, the international risk factor and the exchange rate. This might indicate that contagion between markets works through financial investors. Monetary policy played only a minor role for the outcome of the crisis. However, the monetary policy regime affected the dynamics of both the exchange rate and the change in holdings of local currency by financial investors.
  
  Keywords: Speculative attacks, microstructure, international finance, large players.
  JEL Classification Numbers: F31, F41, G15.
• "Exchange Rate Forecasting, Order Flow and Macroeconomic Information"
  (with Lucio Sarno and Elvira Sojli), Norges Bank Working Paper (2007/2)
  
  This paper investigates the empirical relation between order flow and macroeconomic information in the foreign exchange market, and the ability of microstructure models based on order flow to outperform a naive random walk benchmark. If order flow reflects heterogeneous beliefs about macroeconomic fundamentals, and currency markets learn about the state of the economy gradually, then order flow can have both explanatory and forecasting power for exchange rates. sing one year of high frequency data for three major exchange rates, we demonstrate that order flow is intimately related to a broad set of current and expected macroeconomic fundamentals. More importantly, we find that order flow is a powerful predictor of daily movements in exchange rates in an out-of-sample exercise. The Sharpe ratio obtained from allocating funds using forecasts generated by an order flow model is generally above unity and substantially higher than the Sharpe ratios obtained from alternative models, including the random walk model.
  
  Keywords: Exchange Rate; Microstructure; Order Flow; Forecasting; Macroeconomic News.
  JEL Classification Numbers: F31; F41; G10.
• "'Large' vs. 'Small' Players: A Closer Look on the Dynamics of Speculative Attacks", (with Geir H. Bjønnes, Steinar Holden and Haakon O. Aa. Solheim), March 2007
  
  What is the role of "large players" like hedge funds and other highly leveraged institutions in speculative attacks? In recent theoretical work, large players may induce an attack by an early move, providing information to smaller agents. In contrast, many observers argue that large players are in the rear. We propose a model that allows both the large player to move early in order to induce speculation by small players, or wait so as to benefit from a high interest rate prior to the attack. Using data on net positions of ``large'' (foreigners) and ``small'' (locals) players, we find that large players moved last in three attacks on the Norwegian krone (NOK) during the 1990s: The ERM-crises of 1992, the NOK-pressure in 1997, and after the Russian moratorium in 1998. In 1998 there was a contemporaneous attack on the Swedish krona (SEK) where large players moved early. Interest rates did not increase in Sweden so there was little to gain by a delayed attack.
  
  Keywords: Speculative attacks, microstructure, international finance, large players
  JEL Classification Numbers: F31, F41, G15.
• "Arbitrage in the Foreign Exchange Market: Turning on the Microscope", (with Q. Farooq Akram and Lucio Sarno),  February 2007
  
  This paper investigates the presence and characteristics of arbitrage opportunities in the foreign exchange market using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency, obtained from Reuters on special order. We provide evidence on the frequency, size and duration of round-trip and one-way arbitrage opportunities in real time. The analysis unveils the existence of numerous short-lived arbitrage opportunities, whose size is economically signi.cant across exchange rates and comparable across different maturities of the instruments involved in arbitrage. The duration of arbitrage opportunities is, on average, high enough to allow agents to exploit deviations from the law of one price, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.
  
  Keywords: exchange rates; arbitrage; foreign exchange microstructure.
  JEL Classification Numbers: F31; F41; G14; G15.
• "U.S. Exchange Rates and Currency Flows", Working Paper 4, Stockholm Institute for Financial Research, 2001.
  
  After the Meese & Rogoff 1983-results, researchers have searched with torch for macroeconomic variables with predictive power on horizons shorter than 6 months. Recently, several papers have showed that order flows influence exchange rates intradaily. Maybe order flow may be of importance also for lower frequencies than intraday, like the weekly frequency? In this paper I test a trading model where order flow may be informative due to the existence of private information, and where there are important macroeconomic public information as well. Using weekly data for spot and options trading in the U.S., the model is tested for five exchange rates against US Dollar. For three of the exchange rates, DEM/USD, GBP/USD and CHF/USD, I find that order flow is an important variable for explaining weekly changes in exchange rates. The coefficients are both statistically and economically significant, and have intuitive sign. When U.S banks sell foreign currency, the foreign currency depreciates.
  
  Keywords: Foreign Exchange, International Macroeconomics, Microstructure.
  JEL Classification Numbers: G15; F31; F33.
• "Customer Trading and Information in Foreign Exchange Market", (with Geir H. Bjønnes), Memorandum 30/2000, Department of Economics, University of Oslo.
  
  Recent research point to the possible existence of private information in foreign exchange markets. Dealers claim that customer orders are their most important source of private information, and that banks with a large customer base have a competitive advantage. Previous studies by Lyons (1995), Yao (1998) and ourselves (Bjonnes and Rime, 2000) focus on the dealer's pricing decision under the assumptions that it is only the initiator of a trade that may have private information and that the knowledge of the identity of the counterpart is unimportant when setting prices. In this paper we relax both assumptions. We also consider the dealer's order placement decision. Our results suggest that customer trades influence the placement of orders. The dealers tend to take the same positions as their customers. There is also evidence that dealers price discriminate customers. Spreads to customers are wider than to other dealers. The pricing decision in the interbank market is, however, not affected by customer trades. We find no evidence that dealers price discriminate other dealers they think may be particularly well-informed.
  
  Keywords: Foreign Exchange, Trading, Microstructure.
  JEL Classification Numbers: G15; F31; F33.
• "Private or Public Information in the Foreign Exchange Markets? An Empirical Analysis", Memorandum 14/2000, Department of Economics, University of Oslo.
  
  In macroeconomic models exchange rates are determined by public information. Trading activities are completely irrelevant. In general, these models have low explanatory power for short horizons, which might be due to the possible existence of private information. Dealers in the foreign exchange market consider the order flow from customers to be the most important source of private information. I test a microstructural trading model incorporating private information, including both order flow and macroeconomic variables. The results show that order flow is an important variable for explaining weekly changes in exchange rates, thereby indicating an important role for private information. The strongest effect comes from customer order flow, which highlights the fundamental role of customer demand.
  
  Keywords: Foreign Exchange, International Macroeconomics, Microstructure.
  JEL Classification Numbers: G15; F31.