OlsenBlog

The interest rates associated with individual currencies are one of the most obvious yet least-understood forces in the foreign exchange marketplace. Their most negative effects capture public attention during carry-trade bubbles, such as the recent (summer 2007) rise—and then abrupt fall—of the New Zealand dollar versus the Japanese yen. But day-to-day, currency traders are misled by a broken market mechanism that encourages pricing to skew away from any connection with reality.
In the following interview, Richard Olsen, co-founder of OANDA, discusses this little-understood issue. The solution he recommends—and has put into practice at Olsen and OANDA, the prominent online forex brokerage he founded in 1995—is continuous interest-rate payment, second-by-second, on all open positions.
Continuous interest makes the yield component of every currency transaction real. In a marketplace where fundamentals are few and far between, and where pricing tends to lack any fundamental frame of reference, continuous interest will help stabilize markets and enable incremental intervention to avoid valuation free-falls…

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Enclosed are the slides of a talk that I gave in context of the launch of the Asia-Pacific operation of OANDA Corp. I hope that you will find the content of the slides interesting. The talk explains, why tick by tick screening of market prices is so important for a successful analysis of market trends. It gives recommendations of how retail and institutional investors and corporations should respond to the current crisis. The foreign exchange markets offer significant return opportunities. For corporations and other institutions with currency exposure, the implementation of currency overlays are essential. I then outline, how the governments and central banks can be pro-active to overcome the current crisis. I suggest that they should launch a global early warning system for financial markets and the economy at large, start a program of dynamic foreign exchange interventions to stabilize volatility and finally launch an effort to digitalize the financial markets to get rid of the outdated business practices. You are invited to comment and ask questions…

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The credit and equity markets have been rocked by exceptional events. The currency markets have seemingly been spared of a lot of grief, even though there have been large scale price moves of 20 and 30 percent, but not as detrimental as the events in the other markets. We argue that it is only a matter of time until similarly catastrophic events occur in the currency markets. We argue that central banks have to take a pro-active role in the foreign exchange markets to dampen volatility and prevent big price shocks in the currency market. We are not arguing for large scale interventions, but for an ongoing quantitative intervention strategy to provide market liquidity in the spot currency markets, whenever there is a short-term imbalance of demand and supply. Imbalances of demand and supply have an amplified impact: price spikes trigger margin calls, which lead to a cascade of margin calls setting in train massive price dislocations…

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Since the inception of classical economics over 200 years ago, one of the most sacred assumptions has been the hypothesis that an invisible hand determines market prices and that market prices follow a random walk. Today, there exists significant statistical evidence that this is not the case and we need to acknowledge that financial markets are, indeed, predictable. How is this possible?…

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