Cost of dealing in a foreign exchange market
Abstract
We simulate foreign exchange transactions based on historical records (Deutschmark vs. US Dollar), under the following different scenario: (1) the trader has perfect knowledge of the daily exchange rate, but must have one "buy" and one "sell" transaction per window of predetermined length; (2) Same as in (1), but the trader has the option not to transact in any given window; and (3) the trader has no knowledge at all of the exchange rate, but must, as in case (1), trade twice in every window. The result we obtain is that, in the presence of a transaction cost – which is a certain percentage of the volume being transacted – random trading with no knowledge of the exchange rate invariably results in a net loss. However, it also turns out perfect knowledge of the exchange rate does not guarantee a profitable transaction. The transaction cost and window length play an essential role.
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