The effects of asset price volatility on market participation: Evidence from the Thai foreign exchange market

Existing models of market participation offer contrasting predictions on the impact of asset price volatility on market participation. Utilising granular trading data from the Thai foreign exchange (FX) market, we test the empirical relevance of these predictions. We find that the volatility of the US dollar-Thai baht exchange rate has a positive effect on market participation measured by trading volume and average transaction size. This finding is consistent with the models illustrating that volatility increases participation as it creates profit-making opportunities. The result is robust to controlling for information flow that may generate a positive but non-causal relationship between volatility and participation. We also find heterogeneity across participant types. In particular, the impact of FX volatility on trading volume is positive for foreign end-customers and interbank players, but negative for local end-customers. This heterogeneity is explained by different purposes of FX transactions: financial returns for the former and real demand for the latter. Finally, we show that the impact of volatility on trading volume turns negative at high levels of volatility and during a period of high regulatory uncertainty. (c) 2021 Elsevier B.V. All rights reserved.