Pricing Errors and the Geography of Trade in the Foreign Exchange Market

Abstract

Pricing errors in exchange rates are largest during Asian trading hours and decrease until European–New York overlapping trading hours at which point the cycle begins again. Substantial heterogeneity exists in this pattern across exchange rates. Currencies have smaller pricing errors during their home trading hours, which can be explained by traders facing both lower information-unrelated costs and lower information-related costs during a currency׳s home trading hours. Using methods that are able to unambiguously identify the relative importance of information-related and information-unrelated costs for pricing errors, information-unrelated costs are of first-order importance while information-related costs are of second-order importance.