DON'T REGULATE THE CURRENCY MARKETS: THEIR VOLATILITY REFLECTS THE
PACE OF ARRIVAL OF NEW INFORMATION
Should the foreign exchange (FX) markets be regulated because of
'excessive volatility' and massive trading volume unrelated to the
underlying trade in goods and other financial assets? Is FX trading
'self-generating' so that government-imposed restrictions or taxes
would help ensure that exchange rates are more closely related to
the 'fundamentals' that are supposed to determine exchange rates?
New research by Michael Melvin and Xixi Yin, published in the latest
issue of the Economic Journal, provides evidence on this important
public policy issue by examining the link between the arrival of new
public information, the frequency of quoting FX prices and the
volatility of exchange rates. It indicates that both the number of
price revisions (quotes) and the volatility of exchange rate returns
for the yen and mark are functions of the rate of public information
or news hitting the market. In other words, FX trading is providing
the function it is meant to: adjusting prices and quantities in
response to new information in order to achieve an efficient
allocation of resources.