Analysis of spreads in the dollar/euro and deutschemark/dollar foreign exchange markets

This paper computed bid-ask spreads for the dollar/euro exchange rate market and finds them to be substantially larger than their deutschemark counterparts before introduction of the euro. Larger percentage spreads are not explained by volatility, trade intensity, and other standard explanatory variables in the data sets. Spreads have not increased in terms of the unit (pip) used in exchange rate quotations to the fourth decimal point. Since the euro is worth about two marks, and was initially worth more than a dollar, this finding suggests that larger percentage spreads reflect the more pronounced granularity of quoting conventions in euro-dollar rather than dollar-mark trading. The paper discusses whether mandating quotations to the fifth decimal point might be advisable, and concludes that such a policy might, but need not, increase the foreign exchange market's liquidity.