Volume and Volatility in the FX Market: Does it matter who you are?

The relationship between volume and volatility has received much attention in the literature on financial markets. However, due to the lack of data, few results have been presented for the foreign exchange (FX) market. Furthermore, most studies contain only aggregate series, and cannot distinguish between the impact of different participants or instruments. We study the impact of volume on volatility in the FX market using a unique data set of daily trading in the Swedish krona (SEK) market. The data set covers 95 percent of worldwide SEK trading, and is disaggregated on a number of reporting banks' buying and selling in five different instruments on a daily basis from 1995 until 2002. We find that volume in general show a positive correlation with volatility. However, the strength of the relationship depends on the instrument traded and the identity of the reporting bank. In particular, we find that trading tends to concentrate around the largest banks during periods of high volatility. These banks are probably also best informed. This is especially the case when volatility is high. We interpret this as evidence that heterogeneous expectations are important to an understanding of the volume- volatility relationship.