Foreign exchange markets: price response and spread impact

TL;DR

This paper analyzes the price response functions in the foreign exchange market across multiple years and time scales, revealing how spreads influence market behavior and deviation from Markovian dynamics.

Contribution

It provides a comprehensive large-scale analysis of FX price response functions and quantifies the impact of bid-ask spreads on market response behavior.

Findings

Price response functions peak and then decay over time.

Large bid-ask spreads significantly increase response magnitude.

Market response behavior is consistent across different years and time scales.

Abstract

We carry out a detailed large-scale data analysis of price response functions in the spot foreign exchange market for different years and different time scales. Such response functions provide quantitative information on the deviation from Markovian behavior. The price response functions show an increase to a maximum followed by a slow decrease as the time lag grows, in trade time scale and in physical time scale, for all analyzed years. Furthermore, we use a price increment point (pip) bid-ask spread definition to group different foreign exchange pairs and analyze the impact of the spread in the price response functions. We find that large pip spreads have a stronger impact on the response. This is similar to what has been found in stock markets.