Welcoming remarks
Governor Svein Gjedrem
Norges Bank/BI conference on the microstructure of equity and currency markets
Oslo, 9 September 2005
Dear participants
I am pleased to see you here at this conference on the microstructure of equity and currency markets. More than 60 participants from Europe, Asia and North America are present here today. I wish you all a warm welcome to Oslo.
This conference has been organized jointly with the Norwegian School of Management, and reflects the value Norges Bank places on high quality research.
Research at Norges Bank includes theoretical and empirical research within the areas of monetary policy, financial stability, and asset management. Contributions by our researchers are regularly published in peer-reviewed academic journals.
Our research department enables us to learn about scientific breakthroughs as they happen, and contributes to broadening and deepening the store of knowledge at Norges Bank. This is important to improve our operations. But we can never rest, neither in our central bank operations, nor in our research activities. We need a large international contact base to remain vigorous. This is why it is so important for us to have you here at this conference. Having the opportunity to meet in this way with the very best of international researchers as well as professional practitioners is of great value to us.
Currently, the bank has three researchers with PhDs in microstructure. They have all published their work in recognised international journals. Their research has benefited greatly from cooperation with the Norwegian School of Management, the Oslo Stock Exchange and domestic and foreign banks.
A few years ago, it was unusual to find a conference on market microstructure at a central bank. This may still be the case, but today the microstructure literature does in fact pick up on issues that are highly relevant for both monetary policy and financial stability.
In addition, Norges Bank is the operational manager of the Norwegian Government Petroleum Fund. The management of a fund of this kind is of course no trivial task. We are faced with a wide range of challenges both at the daily operational level and the long-term strategic level. Microstructure is of obvious relevance to our day to day operations. New research on how to minimize transaction costs in different markets and trading systems is very valuable. But recent research also suggests that the microstructure of markets may be relevant at the strategic level. As a large institutional investor with a long investment horizon, Norges Bank would like to see more research on for instance the relationship between expected returns and liquidity.
Microstructure is also relevant for Norges Bank's responsibility for monitoring financial stability. Important stability issues include the effects of globalization and increased competition between different market centers, the degree of market transparency and contagion of liquidity crises across markets.
In June this year, Norges Bank arranged a conference on banking crisis resolution. In his key-note speech, Franklin Allen from Wharton Business School elaborated on the potential factors that contribute to financial crisis, including asset price bubbles, information asymmetries and panics. These are also central issues in the microstructure literature. Large negative market moves, such as the crash in October 1987, are not necessarily consistent with changes in the underlying fundamental values of securities. One source of such extreme events may lie in the design and structure of the trading mechanism.
In a small, open economy, the exchange rate is an important channel for monetary policy. The experience of the last half of the 1990s demonstrated that monetary policy cannot fine-tune the exchange rate. In 1992, during the ERM crisis, Norway experienced an attack on the krone. In 1997, and after the Russian moratorium in 1998, there was again pressure on the krone. In March 2001 the government introduced an inflation target for monetary policy in Norway, and, effectively, a flexible exchange rate. In markets with flexible exchange rates, the themes that participants focus on in the short run may shift in ways that are difficult to reconcile with the macroeconomic fundamentals that anchor exchange rates in the long run.
The microstructure approach to foreign exchange markets has given us a new perspective on how to understand movements in exchange rates, especially at shorter horizons. When participants with opposing views trade, others may learn the dominating view, or theme, by observing the order flow.
Shifts in the themes in foreign exchange markets can be thought of as shocks to the exchange rate. By estimating long-term equilibrium relationships between exchange rates and order flow, we can possibly evaluate whether recent movements are likely to be permanent or not. Norges Bank has recently initiated a project, in cooperation with both domestic and foreign banks, to collect order flow data, for further research on these issues.
We still need to learn more about why order flow is so effective in explaining asset price movements. Many of the key contributors to this literature are present here, and we are very satisfied with the quality of the papers to be presented. I hope that you will have many fruitful discussions and that this conference will contribute to pushing research further.
Thank you