The role of futures trading activity in exchange rate volatility

The relationship between the level of trading in currency futures and the variability in underlying exchange rates is investigated due to growing popularity of currency futures. The level of futures trading and the volatility in the spot rates of the British Pound, Canadian Dollar, Japanese Yen, Swiss Franc and the Deutsche Mark are examined. A volatility measure is applied which is consistent with the return distribution of the underlying currencies being studied. Findings show a positive correlation between the level of futures trading and the volatility in exchange rate changes.