The impact of different players on the volume-volatility relation in the foreign exchange market

Abstract

We examine the volume-volatility relation in the foreign exchange (FX) market using a unique data set from the Swedish krona (SEK) market that contains observations of 90–95 percent of all transactions from 1995 until 2002. We show that the strength of the volume-volatility relation depends on the group of market participants trading. Financial trading volume has the highest correlation with volatility. Interbank trading between the largest Market-making banks is also positively correlated with volatility, while trading among Other market-making banks show no correlation with volatility. Trading by Non-Financial customers is not correlated with volatility at all when controlling for trading by other market participants. Interestingly, we show that (unexpected) spot volume and changes in net positions (spot and forward) by Financial customers Granger cause spot volume and changes in net positions by Non-Financial customers. Our results clearly show that market participants in the FX market are heterogeneous, suggesting that differences in trading strategies and information may explain the volume-volatility relation.