The enormous volume of trading in foreign exchange (FX) markets--almost 100 times the volume on the New York Stock Exchange--has been a puzzle. Economists have turned to a variety of approaches to solve the puzzle--the goods market approach, the asset market approach, and the microstructure approach.
This Economic Letter (based on Ito, et al., 1998) focuses on the microstructure approach, with particular attention to the Tokyo market. In 1994, this market made a change in the way it does business, a change that might seem to have nothing to do with explaining trading volume. The market lifted the restriction on trading during the lunch hour (12:00-1:30). This Letter shows that, in fact, the shift from a lunchtime break to continuous trading provides a natural experiment on one of the underlying motives for trading. In itself, the Letter does not resolve the trading volume puzzle (see, e.g., Lyons 1996 for other microstructure factors that amplify volume). Understanding the motive addressed here does, however, contribute to a resolution.
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