Dynamic Impact of Foreign Exchange Trading Volume on Foreign Exchange Volatility

Jong Woo Kang () and Carlos Cabaero ()
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Jong Woo Kang: Asian Development Bank
Carlos Cabaero: Asian Development Bank

No 768, ADB Economics Working Paper Series from Asian Development Bank

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 (search for similar items in EconPapers)
JEL-codes: F31 G15 G18 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2025-02-06
New Economics Papers: this item is included in nep-mon, nep-opm and nep-sea
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