EXCHANGE RATE RISK and THE BID-ASK SPREAD: A SEVEN COUNTRY COMPARISON

This paper studies the determination of exchange market transaction costs. Using a large data set including seven currencies, it provides empirical support for the theoretical prediction of a positive relationship between the level of uncertainty regarding future prices and current transaction costs. In contrast to most previous work, it considers explicitly the problem of omitted transactions volume, showing that while estimators are less efficient and potentially inconsistent in the absence of the unavailable variable, the direction of potential coefficient bias is such that hypothesis tests regarding the importance of uncertainty are rendered more conservative.