Modeling Returns to Currency Speculation: The Importance of Accurate Trading Costs

Empirical studies of currency trading strategies should incorporate realistic transaction costs. The standard academic methodology overstates transaction costs by failing to take into account the trading strategies of professional investors. The WM London 4pm fixing data is based upon actual tradable prices for a subset of liquid currencies, the remaining less-liquid EM currencies are sourced from indicative quotes or central bank quotes that are not actual tradable prices and are likely to underestimate the actual cost of trading. We also show that bid-ask spreads for currencies vary greatly over time as market conditions change.