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2023 Oct/20
Characteristics of Korean won FX markets and the effects of market opening to non-residents Research Papers 23-07 PDF
Kim, Kyunghun
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This paper studies the effect of Korea’s inter-bank FX market opening to non-residents and the extension of trading hours on the market volatility and trading volume, following the government plan announced in February 2023. It is worth analyzing the effect in a sense that the off-shore won/dollar NDF market has rapidly grown relative to the on-shore spot market while the amelioration of FX market infrastructure resulting from the market opening is the one of the key issues in widening the accessibility of foreign investors.

The growth of off-shore won/dollar NDF trading volume has been noticeable compared with other emerging market currencies. As a result, it affects the won/dollar exchange rate through not only the direct trading between domestic banks and non-residents but also indirect channels through off-shore NDF rates. According to the empirical analysis, the off-shore NDF rates seem to unilaterally affect the spot rate.

The simulation results using the agent-based market model (ABM) show that the market opening has little impact on the exchange rate volatility while the trading volume is expected to increase steadily. Meanwhile, these positive effects could be strengthened if the share of non-residents trading during the extended hours surpasses more than 20 percent of those trading during the regular hours. Also, it is found that the FX market turmoil arising from the market opening could be manageable as the resultant volatility would remain at a similar level to that of the recent global financial uncertainty.

These results imply that no discrimination between residents and non-residents and minimized procedural inconvenience for non-residents are required to induce more non-residents’ participation because sufficient non-residents‘ participation is a crucial element for successful market opening. In addition, the government needs to monitor closely whether any unexpected market turbulence occurs after the market opening. From a longer-term perspective, the market opening should serve as a stepping stone for the internationalization of the Korean won which is a prerequisite for further developing the financial and FX markets and maintaining financial stability of Korea.