Microstructure of trading systems and exchange rate stability


In my opinion, it is possible to observe the process and outcome of trade is at the heart of the "herd" behavior (herding behavior). How does the mechanism of the "herd" behavior? Formally, it is described by the theory of informational cascades (information cascades theory). According to this theory, the behavior of the players based on actual observations of actions of other traders, resulting in the proverbial macroeconomic information does not play an important role. Suppose that every trader has some information about the economy and decides consistently and publicly, whether to keep the domestic currency or to sell it. If it is found so that the first n traders based information analyzed decide to sell, the (n +1)-th trader can ignore their own information, even if it is positive, and sell on the basis of publicly available information to those who were before him. This rule is consistent decision-making leads to the "herd" behavior. Players of the currency market are likely to be doing what other traders make than to act independently on the basis of its own analysis. Thus, the information closeness can be beneficial in terms of monetary stability. As can be seen, transparent financial markets are less liquid and more volatile prices due to "herd" behavior than closed markets. Transparency, oddly enough, at the microeconomic level dilutes the content of economic information that can be extracted from the observation of trade, which, in turn, reduces the incentive dealers compete for order flow. One of the key indicators of liquidity, the spread on the transparency of the market is wider. For example, at Instinet spread less than the NASDAQ, and the NYSE is narrower than on Instinet.

Switch between trading

This analysis leads to the conclusion that the stock market trading by specialists, and the foreign exchange market - with dealers, are associated with more stable prices than automatic electronic trading systems. This does not mean that we should change an established market structure of the domestic currency market. However, in periods of high volatility of the exchange rate, in my opinion, it makes sense to carry out trading mode switching from automatic matching on bilateral trade with price-makers that provided by the rules of operation for the purchase and sale of foreign currency on the MICEX. As a price-maker in the first place, may make parastatal banks Sberbank and VTB Russia - leading operators of hard currency market - whose operations are controlled by the authorities. To increase the liquidity of the price-makers must be other major operators, commercial banks such as the Bank of Moscow and the IMB.

For the price-makers should perhaps be mitigated rules of currency regulation. Role of the main price-maker, in my view, should be given to the Bank of Russia. Immediately it should be noted that the open part of the monetary authorities in the foreign exchange markets is not contrary to market principles. Public welcome foreign exchange intervention by international practice. In such transactions is no shadow of administrative regulation, as there is no specific prohibition for a direct, quantitative limitation or procedure of official approval.

In the event of a threat of a currency crisis, it might make sense to leave the market, only one price-maker - the Bank of Russia. Signal change between trades may make a high index of speculative pressure on the foreign exchange market (currency crisis index), which is a modification to the domestic foreign exchange market has been developed by the author in 2001 g.8 index allows us to characterize the situation in the money market in general, as it includes variables nominal exchange rate, the loss of foreign reserves and interest rate changes. Switch between trade would lead to a more efficient and stable functioning of the foreign exchange market.

First, in the course of trading with price-makers dominate the market order, which ensures low volatility of the exchange rate. Secondly, competition price-makers together keeps tight spreads and increases the liquidity of the market. Thirdly, the market price-makers, compared with an automatic e-commerce, is less transparent, because traders only available pre-trade information, and the behavior of each other, they will not know anything. Information close of trading will reduce the likelihood of the "herd" behavior of traders, which provokes currency crises.