Price behavior and Hurst exponents of tick-by-tick interbank foreign exchange rates

Abstract

Our previous analysis of tick-by-tick interbank foreign exchange (FX) rates has suggested that the market is not efficient on short time scales. We find that the price changes show mean-reverting rather than random-walk behavior (Moody and Wu, 1994). The results of rescaled range and Hurst exponent analysis presented in the first part of this paper further confirms the mean-reverting attribute in the FX data. The second part of this paper reports on the highly significant correlations between Bid/Ask spreads, volatility and forecastability found in the FX data. These interactions show that higher volatility results in higher forecast error and increased risk for market makers, and that, to compensate for this increase in risk, market makers increase their Bid/Ask spreads.