2025年外汇交易量对外汇波动的动态影响（英）.docx

DYNAMIC IMPACT OF FOREIGN EXCHANGE TRADING VOLUME ON FOREIGN EXCHANGE VOLATILITY
Jong Woo Kang and Carlos Cabaero

NO. 768
February 2025

ADB ECONOMICS WORKING PAPER SERIES

ASIAN DEVELOPMENT BANK

ADB Economics Working Paper Series

Dynamic Impact of Foreign Exchange Trading Volume on Foreign Exchange Volatility

Jong Woo Kang and Carlos Cabaero No. 768 | February 2025
Jong Woo Kang ([e-mail]) is the director of Regional Cooperation and Integration Division and Carlos Cabaero ([e-mail])
is a consultant at the Economic Research and Development Impact Department, Asian Development Bank.

The ADB Economics Working Paper Series presents research in progress to elicit comments and encourage debate on development issues in Asia and the Pacific. The views expressed are those of the authors and do not necessarily reflect the views and policies of ADB or
its Board of Governors or the governments they represent.

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DOI: http://dx.doi.org/10.22617/WPS250025-2
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ABSTRACT
Foreign exchange (FX) trading volume is a key factor in exchange rate volatility. Given the important role of volatility in economic growth and stability, this paper investigates the dynamic nature of exchange trading volume on exchange rate volatility using hourly high-frequency data. The estimation results from ordinary least squares, fixed effects and the general autoregressive conditional heteroskedasticity model point to a significant impact of third-party foreign exchange trade volumes on the FX volatilities of original currency pairs. The United States dollar (USD), as the dominant currency, exerts sizeable effect through this third-party channel and the magnitude of the foreign exchange trading volume turns out to be a crucial factor to this effect. However, third-party currency pairs without USD linkages also exert non-negligible impact, calling for renewed attention to the effectiveness of regional financial cooperation in mitigating exchange rate volatility as compared with major foreign exchange trading partners, not only through direct transaction mechanisms but through third party currency channels.
Keywords: FX volatility, third party channel, GARCH model
JEL codes: F31, G15, G18

I. Introduction
The impact of exchange rate movement on economic growth, development, and stability is well- documented. Much of the literature posits that exchange rates affect international trade performance, including through export/import competitiveness, volumes, and prices, as well as businesses’ external financing costs. Consequently, changes in exchange rates affect foreign and domestic consumption, productivity, and investment. Given these significant impacts, private and public entities alike must carefully monitor and prepare for exchange rate movements.
The literature has shown the impact of exchange rates on multiple development and macroeconomic indicators. Eichengreen (2007) frames foreign exchange rates as a vital facilitating condition for economic growth. Development experiences in high-growth economies, such as in East Asia, and developing economies demonstrate that competitive exchange rates are critical in jumpstarting growth. An efficient exchange rate mechanism encourages efficient redeployment of resources to productive sectors, thus unlocking gains in productivity. Studies covering multiple economies across the globe affirm this, particularly that undervaluation of a currency against foreign counterparts is often accompanied by gross domestic product (GDP) growth (Rodrik 2008, Seraj and Coskuner 2021). In a study focusing on India, Shaik and Rao (2020) state that the depreciation of the Indian rupee is associated with an increase in the country’s foreign exchange reserves and in real GDP. Zhao (2020) shows that exchange rates have a direct effect on the prices and costs of commodities, also impacting exports to foreign markets. Further research shows that exchange rates impact productivity and foreign tourism. Fluctuations in the exchange rate may influence economic policy, particularly in economies adopting inflation-targeting regimes, while harming economic growth.
Exchange rates have significant impact on international trade, as noted. Exchange rates have a sizable effect on the import and export costs of products. When an economy’s currency is valued higher, products from foreign markets become cheaper, thus encouraging greater importation. Conversely, undervalued currencies facilitate lower prices for an economy’s commodities and lead to greater product exportation. Thus, movements in the exchange rate also affect an economy’s trade balance; a higher exchange rate moves towards a negative trade account balance, while a lower exchange rate leads to a positive balance, although the growing complexities associated with deepening global value chains tend to compound this linear relationship. The strength of this relationship has been widely studied in the literature, with varying results. Research on developed and developing countries (Kang 2016) after the global financial crisis show that the effect of currency devaluation on export growth post- crisis has not been as

strong as before the crisis. Further research posits that an increase in the number of economies that engage in deeper currency devaluation may lead to sluggish growth in international trade.
Thus, great importance has been placed in understanding exchange rate movements, particularly through the concept of exchange rate volatility. Exchange rate volatility is defined as the risk associated with unexpected movements in exchange rates (Ozturk 2006). The representative indicator of exchange rate volatility is the degree of variance in an exchange rate over a certain period. Price movements originate from an events-based approach, such as political-economic news and announcements, that informs decisions of economic actors, both public and private. Other factors like comparative inflation and interest rate differentials between economies likewise lead to exchange rate volatility.
Aside from macroeconomics and international trade, exchange rate volatility is consequential for firms and traders, which could be exposed to sizeable exchange rate risks in their financing costs and financial management. Volatile foreign exchange markets lead to greater market uncertainty, which impacts costs and revenues for firms and in turn informs hedging and investment strategies. Furthermore, a volatile exchange rate increases uncertainty in the foreign exchange market and discourages risk-averse traders from engaging in investments, leading to changes in investor portfolio flows (Flores-Sosa, Aviles-Ochoa, and Merigo 2023).
Given the influence of exchange rates on economic growth and trade, maintaining a stable and predictable exchange rate has been a constant priority of sovereign financial authorities across the globe. Both the sources and implications of exchange rate volatility have been key areas of economic research. Findings generally show that higher exchange rate volatility leads to higher costs for risk-averse traders, as well as lower foreign trade. This is due to changes in the value of the exchange rate upon the agreement of a contract versus its actual payment and implementation. When exchange rates become volatile, uncertainty rises in predicting the costs and thereby the profits from transactions, which disincentivizes trade (Hooper and Kolhagen 1978). Despite this, other researchers have been less definite about the impact of exchange rate volatility on international trade. De Grauwe (1988), for example, posits that dominance of income effects over substitution effects may lead to a positive relationship between volatility and trade. In this theory, an increase in exchange rate volatility could raise the marginal utility of export revenue in the eyes of sufficiently risk-averse exporters and could induce increased exports. De Grauwe thus suggests that the effect of exchange rate volatility depends on the degree of risk aversion of market players.

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Numerous efforts have been made to study exchange rate volatility. As it is not a directly observable phenomenon, extensive research has been carried out to predict movements in the exchange rates, as well as to identify causes, and possible indicators of exchange rate volatility. The literature identifies economic fundamentals, such as inflation, interest rates, and balance of payments as sources of exchange rate volatility, especially as these factors themselves have become more volatile since the 1980s. Furthermore, factors such as capital account liberalization, technological innovation, and currency speculation all contribute to increased cross-border flows and trade volumes, adding to exchange rate volatility (Hook and Boon 2000). One of the key factors affecting exchange rate volatility is foreign exchange trading volume, which is used as a measure of the state of the foreign exchange market. Foreign exchange trading is essential to engaging in international trade as it allows traders and firms alike to convert domestic currency into foreign currency and vice versa to be able to transact with external markets. Traders often study movement in the forex market and carry out trades based on their valuation of various currencies to make a profit. Thus, fluctuations in forex trading volume are also used to study and predicate the degree of foreign exchange volatility between currencies. This places a clear impetus in understanding the relationship between foreign exchange volatility and trading volumes. Foreign exchange trades can also be influenced by the firm’s motives to minimize losses from exchange rate volatility in determining the timing of exchanges for foreign borrowing or repayment, and the incentives to hedge against exchange rate volatility risks.
The relationship between foreign exchange volatility and foreign exchange trading volumes has been explored in the literature. Foreign exchange trading volume is regarded as a proxy for unobservable market conditions, such as relative liquidity and privately informed trading (Gargano, Riddiough, and Sarno 2018). Volatility tends to move in conjunction with trading volumes, in that a steep increase in trading volumes often coincides with more volatile foreign exchange currencies (Figure on page 4). Various theoretical explanations aim to explain this. Copeland (1976, 1997) presented the model of “sequential information arrival,” wherein trading participants react to information on the financial market individually. Their reaction to the arrival of the news thereby shifts their demand curve for a particular currency. These trades then act as a proxy for traders’ changing demand for a particular currency, and thus coincide with increased volatility in the foreign exchange market. Another explanation for this phenomenon is the “mixture of distributions hypothesis” proposed by Clark (1973). Under this theory, volatility and volume are determined by a common, unobservable factor that reflects the arrival of new information in the foreign exchange trading market. How traders internalize this information changes the pricing of a particular currency, thus encouraging a higher number of trades. These trades therefore signify

disagreements between traders on the pricing of a particular foreign exchange currency and more volatile price movement.
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Average daily volatility
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Figure: USD-JPY Volatility and Trading Volumes for May 2023

USD-JPY = US dollar-Japanese yen currency pair.
Notes: Values above are the daily average of the hourly volatility rates. The hourly volatility rates are calculated as the absolute sum of the 5-minute interval price change of a currency pair within an hour, reflected as a percentage of the exchange rate.
Sources: Asian Development Bank calculations using data from Bloomberg and the CLS FX databases.

Sensoy and Serdengecty (2019) explore the viability of the Mixed Distribution hypothesis by investigating the relationship between USD-TRY (Turkish lira) volatility and foreign exchange trade volumes by currency trade and counterpart. Their results used a generalized method of moments framework to establish a positive contemporaneous relationship between USD-TRY exchange volatility and trade volumes in the spot market. The research further showed that the dispersion of trader beliefs on the future USD-TRY exchange rate significantly increases the positive relationship between vol