WHY DON'T INDIVIDUALS SPECULATE IN THE FORWARD FOREIGN EXCHANGE MARKET?
| Author | Charles A. E. Goodhart,Mark P. Taylor |
| DOI | http://doi.org/10.1111/j.1467-9485.1992.tb00600.x |
| Published date | 01 February 1992 |
| Date | 01 February 1992 |
Scotrish
Joirmd
01
Pohrrcal
Eronom.v.
Vol.
39.
No.
I.
February
1992
1992
Scottish Economic Society
WHY DON’T INDIVIDUALS SPECULATE IN THE
FORWARD FOREIGN EXCHANGE MARKET?
CHARLES
A.
E.
GOODHART*
Financial Markets Group, London School
of
Economics
AND
MARK
P.
TAYLOR*
Research Department, International Monetary Fund Washington, DC,
USA;
City University Business School;
and
Centre
for
Economic Policy Research
I
INTRODUCTION
Some may regard the answer
to
the question posed in the title
of
this paper as
only
too
obvious: because it’s too risky. The objective of the paper
is
to
demonstrate that this is
so
in as rigorous a fashion as possible, utilising both
economic theory and empirical analysis. We show that, given ‘reasonable’
estimates
of
individuals’ coefficients
of
relative risk aversion, the combination
of
riskiness, minimal economical size
of
contract and transactions costs more
generally, will deter the vast majority
of
ordinary people from seeking to
speculate in the forward foreign exchange market.
THE
NO SPECULATION
CONDITION
Standard analyses
of
speculation in the foreign exchange market (eg.
Stockman,
1978;
Frenkel and Razin,
1980;
Hansen and Hodrick,
1983)
generally start from a variant
of
the statement that
‘...
the first-order condition
for
the representative investor requires that the conditional expectation of the
marginal utility
of
the nominal profit from contracting in the forward exchange
market
...
must be zero’ (Hansen and Hodrick,
1983,
p.
1117).
We seek to
*
We are grateful
to
an anonymous referee and
to
an editor
for
helpful comments on an
earlier draft, although responsibility for any remaining errors remains with
us.
Any views
expressed are
ours
and are not necessarily those
of
the International Monetary Fund.
Date
of
receipt
of
final manuscript:
13
May
1991.
I
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