Speculation in the Spot and Currency Derivative Markets

Abstract

Speculation in the foreign exchange market is a subject that has been dealt with in the early writings on exchange rate economics. Early contributors to the post-war literature on exchange rate economics were to a large extent concerned with the role of speculation in the foreign exchange market. Nurkse (1945) warned against the dangers of “bandwagon effect” as a source of market instability. In his seminal work on the choice between fixed and flexible exchange rates, Friedman (1953) argued for flexible exchange rates by suggesting that speculation would be stabilising under flexible exchange rates because profit-making requires buying low and selling high, which is the action that makes speculation stabilising. A proof of this proposition will be presented later.