No full-text available
To read the full-text of this research,
you can request a copy directly from the author.
FX Trading and Exchange Rate Dynamics
Abstract
This paper provides new perspective on the poor performance of exchange rate models by focusing on the information structure of FX trading. I present a new theoretical model of FX trading that emphasizes the role of incomplete and heterogeneous information. The model shows how an equilibrium distribution of FX transaction prices and orders can arise at each point in time from the optimal trading decisions of dealers. This result motivates empirical investigation of how the equilibrium distribution of FX prices behaves using a new data set that details trading activity in the FX market. This analysis produces two striking results: (i) Much of the observed short-term volatility in exchange rates comes from sampling the heterogeneous trading decisions of dealers in an equilibrium distribution that, under normal market conditions, changes comparatively slowly. (ii) In contrast to the assumptions of traditional macro models, public news is rarely the predominant source of exchange rate movements over any horizon.
... These D2000-1 data have been used to analyse a number of issues in the foreign exchange market, all placing great importance on order flow. The high frequency dynamics of the data are discussed in Evans (2001) and the cross market effects of order flow are illustrated in Evans and Lyons (2002a). Evans and Lyons (2003) ask how macroeconomic news is incorporated into price, in particular, whether information enters directly or whether it enters via order flow. ...
... Detailed investigations of liquidity supply on this trading platform are presented in Daníelsson and Payne (2002a) and Daníelsson and Payne (2001), while Payne (2003a) uses the data to examine the effects of order flow on FX returns. Using a VAR framework, Payne (2003a) finds a long run cumulative effect of order flow on DEM/USD price changes, consistent with the findings of Lyons (1995) and Evans (2001) where order flow was found to carry private information. 12 Whereas Payne (2003a) examines the effects of order flow (net buying pressure via executed market orders), the effects of net buying/selling pressure from unfilled limit orders left on the book are examined in Love and Goodhart (2004). ...
... The model 1 See also the models of Easley and O'Hara (1987), Madhavan and Smidt (1991) and Evans and Lyons (2002b). Empirical results showing the effects of order flow on FX rates include Lyons (1995), Yao (1998), Evans (2002) and Payne (2003a). 2 The quote by Andersen and Bollerslev at the head of this chapter has not yet been adequately researched. Andersen and Bollerslev (1998) do not test their 'hectic trading' hypothesis due to the unavailability of transactions data in their study. ...
This thesis brings together a number of studies using high frequency foreign exchange (FX) data. The first part examines the effects of scheduled, publicly released macroeconomic news, while the final chapter considers another, related, aspect of FX microstructure. Chapter 1 provides an introduction to the thesis and reviews the literature in high frequency empirical FX research. In Chapter 2, I use up to ten months of FX transactions and quote data to analyse foreign exchange activity around times of scheduled news releases. The effects of news on exchange rate levels are examined, as well as the effects on spreads, trading volume and volatihty. Chapter 3 extends this analysis, asking how public information enters prices. Under rational expectations and efficient markets hypotheses, the news contained in public information announcements should be impounded directly, with there being no role for trades in this process of information assimilation. However, the results suggest that up to two thirds of the price relevant information enters via trading (order flow in particular). Chapter 4 provides an explanation why order flow is so important around public news releases and also examines the effects of news on market depths. In Chapter 5 I examine how much information is carried in trades by looking at the price impact of order flow when feedback trading is allowed. The model that is often used in the literature is proved to be misspecified when temporally aggregated data are employed and Chapter 5 introduces a method to estimate the otherwise unidentified model. Using impulse response functions, I show that trades actually carry more information than previous estimates suggest.
... These transactions are signed positively or negatively and vary according to whether the trader is buying or selling, respectively. In other words, a positive sum over the period indicates pressure to buy, while a negative sum indicates pressure to sell. 5 For evidence that foreign exchange order flow conveys information, please see Lyons (1995); Covrig and Melvin (1998); Ito, Lyons, and Melvin (1998); Yao (1998); Payne (1999); Cheung and Wong (2000); Naranjo and Nimalendran (2000); and Evans (2002). 6 Please see Evans and Lyons (2004a). ...
... For example:Evans (2002);Evans and Lyons (2002, 2004a);Payne (2003);Bjones, Rime and Solheim (2005); andCarlson and Osler (2005). 2 Please seeMeese and Rogoff (1983);Frankel and Rose (1995);Flood and Taylor (1996);Cheung et al. (2002);Evans and Lyons (2004a); andEngel and West (2005). ...
... For example:Evans (2002);Evans and Lyons (2002, 2004a);Payne (2003);Bjones, Rime and Solheim (2005); andCarlson and Osler (2005). 2 Please seeMeese and Rogoff (1983);Frankel and Rose (1995);Flood and Taylor (1996);Cheung et al. (2002);Evans and Lyons (2004a); andEngel and West (2005). ...
... 3 Several authors, e.g. Lyons (1995), Payne (2002), and Evans (2002) study the relationship between order flow and foreign exchange rates. Evans and Lyons (2002a) consider cross exchange rate order flows in their study of information integration. ...
... Lyons (1995), Payne (2002), and Evans (2002) study the relationship between order flow and foreign exchange rates. Evans and Lyons (2002a) consider cross exchange rate order flows in their study of information integration. The objective of this paper is to investigate the relationship between order flow and FX rates, extending extant research in two areas: The simultaneous use of multiple exchange rates to investigate cross exchange rate relationships and a Meese–Rogoff test of the order flow model. ...
... Recent empirical work supports this intuition, e.g. Evans and Lyons (2002b) who find strong dependence of daily exchange rate changes on daily order flows, even after accounting for macroeconomic fundamentals. ...
The dependence of foreign exchange rates on order flow is investigated for four major exchange rate pairs, EUR/USD, EUR/GBP, GBP/USD and USD/JPY, across sampling frequencies ranging from 5 minutes to 1 week. Strong dependence and explanatory power is discovered across sampling frequencies. In a new result, inter–market effect of order flows is discovered, where the GBP exchange rate is dominated by EUR/USD order flow. The Meese and Rogoff (1983a,b) framework is used to investigate the forecasting power of order flow and it is shown that the order flow specifications reduce RMSEs, relative to a random walk, for virtually all exchange rates and sampling frequencies.
... Meanwhile, microstructure approach suggests that in addition to the direct impact of public information, both publicly available and unavailable information is impounded in exchange rate indirectly and gradually through trading process due to the low transparency of trades in foreign exchange market, thus shifts exchange rate accordingly (see e.g. Lyons, 2001; Evans, 2002, 2008; Evan and Lyons, 2005a, 2008a,b; Love and Payne, 2008; Rime et al., 2008). The micro approach therefore complements, not compete with, macro approaches. ...
... O'Hara (2004) suggests that liquidity relates to the ability to buy and sell assets easily and that in a liquid market buyers and sellers can trade into and out of positions quickly without having large price effects. As such, trades have greater price impacts in less liquid markets, other things equal (Evans and Lyons, 2002c). Therefore, if market liquidity varies over time and between up and down markets, agents might not be able to trade out of unwanted positions in liquidity-constrained markets, i.e. market disequilibrium occurs. ...
... Each of these views has a different policy implication towards liquidity, restraining or fostering, which will be examined under the context of foreign exchange markets in this paper. Based on Evans and Lyons (2002a,b)'s portfolio shifts (E&L) model, we develop a more general theoretical model which allows for varying short-term liquidity provision. Our model, thus, assumes that short-term market disequilibrium could occur either because of insufficient speculative demands in liquidity-constrained markets or because of excess speculative demands in liquid markets though the market will eventually return to equilibrium. ...
This paper extends the portfolio shifts model advanced by Evans and Lyons (2002a,b) by allowing for persistent mispricing and asymmetric pricing impacts of order flow. In particular, market under- and overreactions could happen and persist due to the presence of `behaviourally biased' traders while the asymmetric pricing impacts stem from varied risk aversion degrees of agents. The derived theoretical model, called the asymmetric portfolio shifts (APS) model, can be shown to be empirically equivalent to the nonlinear autoregressive distributed lag framework proposed by Shin et al. (2009). Using Reuters D2000-1 trading data set, we find strong evidence of an asymmetric cointegrating relationship between exchange rate and order flow. Specifically, exchange rates react to order flows in a nonlinear fashion with the pricing impacts of trades in down market being significantly greater than in up market. Furthermore, the dynamic multiplier effects from our model suggest two typical patterns of the price discovery process: one following market underreaction is characterised by gradual and persistent adjustment, and one following market overreaction by short-term overshooting, volatile but faster adjustment. We also document that overreaction is more prominent in down market. Finally, our results clearly show that feedback trading strategies can either stabilise or destabilise the market depending on market conditions. Overall, our empirical results support the validity of the proposed APS model.
... 6 The use of intraday retail investor order flow in our analysis is 6 Several papers examine the effects of Inter-dealer order flow on FX prices. See for example, Cai et al. (2001), Lyons (2001), Evans and Lyons (2002a,b,c), Evans (2002), Rime (2003) , Andersen et al. (2003), Osler (2005), Evans andLyons (2005, 2006) and Danielsson & Love (2006), Dominguez and Panthaki (2006), Evans & Lyons (2008), Berger et al. (2008), Love and Payne (2008), Phylaktis and Chen (2010) , Rime et al. (2010). Flows from individual end-user segments in necessary and important because typically only intraday interdealer order flow is studied in the literature, such as Andersen, Bollerslev, Diebold and Vega (2003), who find price effects from scheduled macro announcements. ...
... 6 The use of intraday retail investor order flow in our analysis is 6 Several papers examine the effects of Inter-dealer order flow on FX prices. See for example, Cai et al. (2001), Lyons (2001), Evans and Lyons (2002a,b,c), Evans (2002), Rime (2003) , Andersen et al. (2003), Osler (2005), Evans andLyons (2005, 2006) and Danielsson & Love (2006), Dominguez and Panthaki (2006), Evans & Lyons (2008), Berger et al. (2008), Love and Payne (2008), Phylaktis and Chen (2010) , Rime et al. (2010). Flows from individual end-user segments in necessary and important because typically only intraday interdealer order flow is studied in the literature, such as Andersen, Bollerslev, Diebold and Vega (2003), who find price effects from scheduled macro announcements. ...
This paper examines the trading behavior of individual investors using a proprietary intraday dataset of a large pool of retail investor aggregate (minute by minute) long and short positions in EUR/USD for the period July 2014 to April 2016. Standard event study analysis shows no significant adjustment in trading ahead of scheduled macro news announcements and trading contrary to the announcement surprise after the event. A panel regression analysis shows that the contrarian trading behavior is mostly driven by lagged returns rather than fundamental macro news. Further intraday time series analysis shows that the lagged overall news sentiment also significantly affects investor net order flow. Finally, we show that simple cross-over trading strategies that exploit retail investor order flow imbalance are profitable. Overall our results suggest that retail investors in currency markets follow the news and are influenced by news sentiment and past returns, but do not possess the skills to extract fundamental information from public news. Their trading behavior contributes to the slowdown of the price discovery process. Our findings support the differential abilities of market participants to interpret public information as an explanation for the importance of order flow in price formation in currency markets.
... Moreover, Osler (2001)'s critique showed that the assumptions underlying many models are in fact so tenuous that conclusions drawn from them against an order-flow hypotheses may be just as tenuous. Goodhart and Payne (1996), Osler (1998), Evans andLyons (1999), Rime (2000), Lyons (2001), and Evans (2001) all suggest that order-flow is pivotal in defining short-run currency movements. Osler (2001 and takes a micro-structural approach to explain the success of familiar technical predictions: the triggering of stop-loss driven price cascades. ...
... Foreign exchange literature suggests that news flow can indeed be secondary to orderflow in driving exchange price movements (Cai, Jun, Van-Leung, Lee andMelvin, 2001 andEvans, 2001 thinking that they reflected genuine information flow (Osler, 2002). Osler (2001) studied 9,700 currency stop-orders from an institutional forex stop-order book across nearly seven and half months. ...
- Technical and fundamental analysis of financial markets and macroeconomic cycles
- Behavioural financial economics and heuristics
- Forecasting surveys
- Behaviour surveys
- Non parametric statistics
- Computational statistics
- Machine learning and big data
- Bootstrap methodologies
- Kernel Density Estimators
- Structural instability and breaks
- Technical analysis is the study of price movements in traded markets so as to forecast future movements or identify trading opportunities. Following a review of the history and research of technical analysis, three empirical chapters evaluate a number of propositions popular among technical analysts.
One approach used widely over the last century assumes that support and resistance levels can be predicted by projecting the ratios between the length and duration of successive trends, in particular using Fibonacci ratios like 1.618. This proposition is rejected for the Dow Jones Industrial Average by identifying turning points and testing for clustering by developing a block bootstrap procedure. A few significant ratios appear to support such anchoring by the market, but no more than would be expected by chance.
The thesis then reports a survey based experiment that tests whether individuals themselves do have an in-built tendency to anchor forecasts of future trends on previous trends. The significance of the survey results are tested using a novel kernel density estimator based bootstrap methodology. Respondents' forecasts do bear some relationship to the size of the most recent trend by certain whole-number ratios by more often than would be expected by chance.
The third experiment addresses the criticism that academic studies do not use a rich enough characterisation of technical analysis. 120 active market-timing strategies are tested using a regression based framework of equity fundamentals, macroeconomic fundamentals, behavioural variables and a diverse set of mainstream statistical indicators from technical analysis. Our recursive approach uses time-invariant rolling and expanding estimation windows as well as conditional windows based on the presence of structural breaks, identified using the conditional reverse ordered cusum method (ROC), of Pesaran and Timmermann (2002). Models that include both fundamental and technical indicators perform well, even allowing for realistic levels of transactions costs. And accounting for structural instability via the ROC method also improves performance.
... In this paper, we use a wider set of macroeconomic news types compared to the previous studies and examine whether this set of macroeconomic news affects the price discovery process differently from the previous studies. For example, Evans (2002) decompose macro news into common knowledge and non-common knowledge shocks and find that non-common knowledge shocks are of greater importance in price discovery. In our news dataset, most Australian macroeconomic announcements arrive during the Asian trading hours (i.e. from 23:00 GMT on day t-1 to 1:00 GMT on day t), while most of the US macroeconomic announcements occur during the "NYLON" and North American markets (i.e., from 12:00 GMT to 19:00 GMT). ...
... There is a long-standing debate about the influences of market concentration. For example, on the one hand, the market concentration enables the top-tier banks to process greater order flow and internalize customer order flow, which helps them aggregate the dispersed information among the customers and contribute more to the price discovery (Evans 2002;Evans and Lyons 2002a;Rime and Schrimpf 2013). On the other hand, the market concentration may cause erratic swings amid liquidity drought, especially during times of market stress (Yin 2005;Hendershott and Jones 2005). ...
With Australia's growing importance in the global economy, the Australian dollar (AUD) has started to play a significant role in the global Foreign Exchange (FX) market. Using intraday trading data over the period of January 1999 to December 2013, we examine the determinants of price discovery in the AUD markets at two different time horizons. We find that the short-run determinants of price discovery include macroeconomic news, order flows and market state variables (i.e., return, volatility, trading volume and bid/ask spread). After controlling for the cross-region information flow and dynamic self-dependence, we find that more favorable market states and more unexpected order flows on macroeconomic news announcement days make a significant contribution to price discovery in the AUD market. Furthermore, we found that a higher level of market integration and consolidation contributes to price discovery process in the long-run.
... Most empirical studies on the relationship between nominal exchange rates and order flow in the finance literature have relied on high-frequency data, such as daily, hourly and fiveminute (e.g. Evans and Lyons, 2002a, 2002b, 2008Evans, 2002Evans, , 2010Froot and Ramadorai, 2005; Rime, Sarno and Sojli; 2010, Guo, 2017a, Guo, 2017b, and the traditional econometric tools (such as OLS). However, it is well known that the direct use of high frequency data in traditional econometric estimations has several drawbacks. ...
... The dataset of order flow is the same as in Evans (2002) 4 , and readers can refer to that paper for details. The original dataset contains time-stamped, tick-by-tick observations on actual transactions on the Reuters D2000-1 system for the largest spot market (DM/$) over a fourmonth period, May 1 -August 31, 1996. ...
The so-called “foreign exchange rate determination puzzle” has been a hard topic in international finance for several decades. The puzzle illustrates the weak explanatory power of macroeconomic-based models of the nominal exchange rate fluctuations. We investigate the foreign exchange rate determination puzzle in a continuous-time framework. Following the market microstructure literature, a simple model of the determination of foreign exchange rates is developed, and the model concludes a result which is essentially a continuous-time version of the equation in Evans and Lyons (2002a). For estimation, we take an advantage of a newly-developed econometric tool based on a time change from calendar to volatility time. With this new estimation methodology, our results indicate that the effect of order flow on exchange rate is significantly improved compared with the traditional econometric tools.
... In this paper, we use a wider set of macroeconomic news types compared to the previous studies and examine whether this set of macroeconomic news affects the price discovery process differently from the previous studies. For example, Evans (2002) decompose macro news into common knowledge and non-common knowledge shocks and find that non-common knowledge shocks are of greater importance in price discovery. In our news dataset, most Australian macroeconomic announcements arrive during the Asian trading hours (i.e. from 23:00 GMT on day t-1 to 1:00 GMT on day t), while most of the US macroeconomic announcements occur during the "NYLON" and North American markets (i.e., from 12:00 GMT to 19:00 GMT). ...
... There is a long-standing debate about the influences of market concentration. For example, on the one hand, the market concentration enables the top-tier banks to process greater order flow and internalize customer order flow, which helps them aggregate the dispersed information among the customers and contribute more to the price discovery (Evans 2002;Evans and Lyons 2002a;Rime and Schrimpf 2013). On the other hand, the market concentration may cause erratic swings amid liquidity drought, especially during times of market stress (Yin 2005;Hendershott and Jones 2005). ...
... Also, the FX derivatives markets behave quite differently from the spot market. This thesis mainly focuses on the spot market, which is the second-largest submarket, closely following the FX swap market in 2013 (BIS, 2013a, Table 1), and where most of the price discovery takes place [3]. The FX spot market is a decentralized multiple-dealer market. ...
... Trade occurs when another dealer who demands liquidity enters a market order. 3 Compared to direct trading, the limit order market is more transparent in the sense that the orders are partially revealed and publicized. Also, the limit order market is anonymous as it is impossible to identify the counterparty until the deal is struck. ...
... Important empirical work of recent years indicates that order flow is a critical determinant of high-frequency exchange rate movements (Goodhart, Ito, and Payne (1996); Evans and Lyons (1999); Rime (2000); Lyons (2001); Evans (2001)). This paper broadens our appreciation for the potential contribution of order flow to exchange rate dynamics, by showing that stop-loss orders may contribute to price cascades and, thereby, to excess kurtosis. ...
... This has potential implications for both theoretical and empirical work. For example, path dependence is inconsistent with the random walk assumption (Evans (2001)) and the related assumption of a simple diffusion process (Andersen et al. (2001)). The path dependence of exchange rates may also help explain why technical analysis has a track record of forecasting success while standard exchange rate models do not. ...
In this paper, I provide evidence that currency stop-loss orders contribute to rapid, self-reinforcing price movements, or "price cascades." Stop-loss orders, which instruct a dealer to buy (sell) a certain amount of currency at the market rate once the rate has risen (fallen) to a prespecified level, generate positive-feedback trading. Theoretical research on the 1987 stock market crash suggests that such trading can cause price discontinuities, which would manifest themselves as price cascades. ; My analysis of high-frequency exchange rates offers three main results that provide empirical support for the hypothesis that stop-loss orders contribute to price cascades: (1) Exchange rate trends are unusually rapid when rates reach exchange rate levels at which stop-loss order have been documented to cluster. (2) The response to stop-loss orders is larger than the response to take-profit orders, which generate negative-feedback trading and are therefore unlikely to contribute to price cascades. (3) The response to stop-loss orders lasts longer than the response to take-profit orders. Most results are statistically significant for hours, although not for days. Together, these results indicate that stop-loss orders propagate trends and are sometimes triggered in waves, contributing to price cascades. Stop-loss propagated price cascades may help explain the well-known "fat tails" of the distribution of exchange rate returns, or equivalently the high frequency of large exchange rate moves. The paper also provides evidence that exchange rates respond to noninformative order flow.
... The evidence found in this study of strong mean reversion in dealer inventories, but weak inventory effect through price, is consistent with the findings in Manaster and Mann (1996) for futures dealers. Recent studies like Evans and Lyons (2002) have integrated insights from microstructure to address the inability of macro models to explain exchange rate changes at frequencies higher than a year. They demonstrate that daily aggregate order flow may improve explanatory power significantly . ...
... Compared with new data sets with transaction prices from electronic trading systems, e.g. Payne (2003) (D2000-2) and Evans (2002) (D2000-1), our data set has the advantage that it includes dealer inventories and reflects the dealers' choice between different trading systems. Thus, our data allows a direct test of inventory models and the investigation of trading strategies. ...
We study dealer behavior in the foreign exchange spot market using detailed observations on all the transactions of four interbank dealers. There is strong support for an information effect in incoming trades. The direction of trade is most important, but we also find that the information effect increases with trade size in direct bilateral trades. All four dealers control their inventory intensively. Inventory control is not, however, manifested through a dealer's own prices in contrast to findings by Lyons (J. Financial Econ. 39(1995) 321). Furthermore, we document differences in trading styles, especially how they actually control their inventories.
... It is an empirical issue as to whether adverse selection or inventory considerations drive the liquidity that market-makers provide in different markets and under what conditions. Pasquariello and Vega (2006); Green (2004); Brandt and Kavajecz (2004); Cohen and Shin (2003); Fleming (2003); and empirical results for the currency markets (see Evans (2002) ;Evans, and Lyons (2002)) show that adverse selection is important in determining prices, even in markets driven largely by public information. However, it is unclear how important these considerations are in affecting the relation between trading activity and liquidity during nonannouncement periods. ...
... Finally, we include an AR(1) adjustment because we find evidence of serial correlation in price changes at short horizons in unreported results. This negative serial correlation is consistent with those found for equity price changes in Hasbrouck (1991) and foreign exchange price changes in Evans (2002). Table V These results are consistent with those of Fleming (2003), who examines the 2-year Treasury note at 5-minute intervals using all periods (announcement and nonannouncement) during the New York trading hours. ...
... hierzu und zum Folgenden Lyons (2001), S. 255 f. von Untersuchungen nachgewiesen. Hier sind zum Beispiel die Arbeiten von French und Roll (1986), Hasbrouck (1991), Rime (2000) Evans und Lyons (2002), Evans (2002) oder auch von Payne (2003) zu erwähnen. Darüber hinaus deuten auch einige auf Befragungen von Devisenhändlern basierende Arbeiten auf den Informationsgehalt des Order Flows hin. ...
... Siehe hierzu zum Beispiel die Arbeiten vonFrench und Roll (1986),Hasbrouck (1991),Rime (2000),Evans und Lyons (2002),Evans (2002) sowie vonPayne (2003). ...
... In this paper we use the taxonomy suggested by Evans (2002) to classify different categories of news announcements into two groups. Using his definition and following the literature which takes quoting activity as a proxy for the number of transactions, allows us to classify news announcements according to whether they impact quoting activity or not. ...
... This is in line with the findings of Andersen, Bollerslev, Diebold, and Vega (2002), that macroeconomic surprises have the most significant impact on the level of the exchange rate. According to Evans (2002), these types of announcements are therefore NCK news, as they impact order flow. Given that they are simultaneously received by all dealers, it has to be the case that they are interpreted differently. ...
We investigate the information content of dealers' quoting activity as measured by the fre-quency of price revisions in the Euro/Dollar foreign exchange market. We use the multivariate double autoregressive conditional Poisson model designed for time series of count data. We find that dealers react differently to the same news announcements, some dealers increasing their activity, whilst others decrease it in response to the same news. We attribute this to the heterogeneous interpretation of the news content by individual traders and to the significant influence of some dealers on others. We also find very significant interaction between dealers' quoting activity, which suggests that dealers monitor the quoting activity of others to infer their private information and their interpretation of public news announcements. participants at the microstructure sessions in the 21 th AFFI International Conference (France), the European Financial Management Association, EFMA 2004 meeting in Basel (Switzerland) and the Econometric Society European Meeting 2005 in Madrid, for helpful discussions and suggestions. This work is supported in part by the European Community Human Potential Programme under contract HPRN-CT-2002-00232, Microstructure of Financial Markets in Europe. The usual disclaimers apply.
... This section examines how the size distribution and clustering tendencies of currency orders contribute to high kurtosis in order flow. Empirical evidence shows that order flow affects returns: a currency's value tends to rise when buy orders dominate aggregate order flow, and to fall when sell orders dominate (Evans and Lyons 2002). Thus kurtosis in order flow will be reflected in kurtosis in returns. ...
... We create thirty separate series of orders, sampling order sizes at random from the three observed order-size distributions. We take one " period " to represent one half hour, since this appears to represent the time until a transaction has its maximum exchange rate impact (Payne and Vitale 2003; Evans 2002).Each order series lasts 62,400 periods, which corresponds to five years of 24-hour trading days with 260 trading days per year. ...
What triggers extreme returns in financial markets? In standard theoretical models news is the only trigger, but in foreign exchange and equity markets extreme returns often occur in the absence of news. This paper investigates how the distribution of currency returns, and in particular the frequency of extreme returns, is influenced by price-contingent trading, a category that includes most technical trading, algorithmic trading, and dynamic option hedging. In so doing it suggests that extreme exchange-rate returns and (more generally) high return kurtosis are statistically inevitable even in the absence of news. Using data on price-contingent currency orders we identify four microstructural sources of return kurtosis: (1) high kurtosis in the size distribution of price-contingent orders; (2) clustering of price-contingent order executions at certain times of day; (3) clustering of order executions at certain price levels; and (4) the feedback from returns to trades. When each factor operates in isolation, kurtosis in the order-size distribution contributes the most to return kurtosis. When the factors operate simultaneously, however, their interactions prove far more important than any single one. Together, these features of price-contingent trading can account for a substantial fraction of observed kurtosis in exchange-rate returns.
... Ceva mai rar, au fost întreprinse şi cercetări asupra variaţiilor sezoniere prezente pe pieţele valutare (McFarland et al., 1982;So, 1987;Cornett et al., 1995;Payne, 1996;Aydoğan & Booth, 2003;Yamori & Mourdoukoutas, 2003;Yamori & Kurihara, 2004;Berument et al., 2007). La fel ca în cazul tranzacţiilor de pe pieţele de capital, cele din pieţele valutare pot avea o dimensiune speculativă consistentă, care favorizează apariţia anomaliilor calendaristice (Frankel & Froot, 1986;Canova & Marrinan, 1993;Vitale, 2000;Danıelsson & Payne, 2002;Evans, 2002). Totuşi, spre deosebire de evoluţiile pieţelor de capital, cele ale pieţelor valutare pot fi influenţate decisiv de intervenţia activă a băncii centrale (Lewis, 1995;Morana & Beltratti, 2000;Westerhoff, 2001). ...
... For example, Diebold, Piazzesi, and Rudebusch (2005) and Piazzesi (2005) examine the impact of domestic macroeconomic factors on the yield curve. Brandt and Kavajecz (2004) and Green (2004), in the spirit of Evans (2002) and Evans and Lyons (2002), examine the impact of order flow on Treasury yields. See Bernanke, Reinhart, and Sack (2004) for a high frequency study of the very short-run impact of foreign official purchases. ...
Foreign flows have an economically large and statistically significant impact on long-term interest rates. Controlling for various macroeconomic factors we estimate that had there been no foreign flows into U.S. bonds over the past year, the 10-year Treasury yield would currently be 150 basis points higher; even a step-down to average inflows would imply an increase of 105 basis points. The impact of the headline-making foreign official flows -- a relatively small subset of total foreign accumulation of U.S. bonds -- is also significant but markedly smaller. Our results are robust to a number of alternative specifications.
... 65 Es wird z.B. auch von Lux (1995Lux ( , 1997 verwendet. Ferner folgt es Calvo und Mendoza (1998b) (2000); Evans (2002); Evans und Lyons (2002); Ito et al. (1998);Lyons (1995); Naranjo und Nimalendran (2000). Es ließe sich aber auch in empirischen Studien als Näherungswert für die Erwartungen der Marktteilnehmer verwenden. ...
... En Evans y Lyons (2004 b) se responde a diversas críticas relacionadas con este enfoque. 3 Por ejemplo, Evans (2002), Evans y Lyons (2002, Payne (2003), Bjones, Rime y Solheim (2005) y Carlson y Osler (2005). 4 Interés abierto es la suma de posiciones largas y posiciones cortas vigentes de una moneda. ...
Este trabajo analiza si la relación entre los cambios en las posiciones netas de los especuladores de monedas de cinco economías desarrolladas en el Chicago Mercantile Exchange y los cambios porcentuales semanales en los tipos de cambio con respecto al dólar estadounidense de dichas monedas es estable en el tiempo, o bien depende, en alguna medida, del tamaño del mercado para los contratos de futuros de dichas monedas. Los resultados sugieren que no puede rechazarse la hipótesis de que el crecimiento del mercado incide sobre la sensibilidad del tipo de cambio ante una variación en las posiciones netas de los especuladores.
... 6 Breedon and Ranaldo (2013) finds that local currencies tend to depreciate during their own market opening hours because a local currency tends to sell more. Evans (2002), based on intraday quotes, trade intensity, and order flow data on DM/USD, argues that the transactions driven by non-common knowledge can give rise to an equilibrium distribution of transaction prices rather than a single price level. In addition, when trade intensity is high, non-common knowledge yields significant variances and price movements even for long-term dynamics. ...
This paper investigates the predictability of jumps in currency markets and shows the implications for carry trades. Formulating new currency jump analyses, we propose a general method to estimate the determinants of jump sizes and intensities. We employ a large panel of high-frequency data to reveal significant predictive relationships between currency jumps and national fundamentals. In addition, we identify intraday patterns such as multiple currency jump clustering and time-of-day effects. U.S. macroeconomic information releases - particularly FOMC announcements - lead to currency jumps. Using these jump predictors to construct jump-robust carry trades, investors can mitigate the left tail risks.
... 2 Prior research on currency markets has focused on the link between expectations and shocks hitting currency markets (Evans, 2002;Evans and Lyons, 2002). While information-driven shocks change expectations and often increase market volatility (see, e.g., Jiang et al., 2011;Ederington and Lee, 1995;Ederington and Lee, 1993), price-contingent trading could also trigger large FX market swings even in the absence of any news arrivals (Osler, 2005;Osler and Savaser, 2011). ...
This article investigates a trading strategy that relies on private information in an electronic spot foreign exchange market. In a structural microstructure model extended for high-frequency data, our analysis links the informational content of trading activity to order size. We find that large currency orders are likely to be placed by informed traders during increased price volatility episodes. In addition, the data suggest that excess kurtosis in exchange rate returns (corresponding to large price-contingent trades) is significantly lower than that in small trades.
... More recently, variants of the order imbalance methodology have been used to analyse the foreign exchange and fixed income markets. Evans and Lyons (2002) and Evans (2002) provide evidence that order flow contains information about economic fundamentals, and so performs an important function that explains price movements. Pasquariello and Vega (2007) find that unanticipated order flow has a significant and permanent impact on daily bond yield changes, and correlation between order flow and price changes is higher when the dispersion of beliefs among market participants is high. ...
Order imbalance methodology is utilized to examine the link between trading activity and returns in the six most liquid international bond futures markets. Order imbalances are strongly related to contemporaneous returns, in the expected direction (i.e. excess buy (sell) orders push down (up) yields), even after controlling for aggregate market volume. There is evidence of contrarian investor behaviour following an increase in yields, but continuation of order imbalances when yields are falling (the prices of bond futures are rising). International bond futures markets are strongly intertwined with the US market having a strong influence on the returns and order-flow across all countries; this is likely an indication of the spill-over effect of US macroeconomic data.
... Next, Figure 1 shows substantial price discovery at the beginning of day 97 in 2001, so we examine the first trade of the day (first) to determine if the overnight period is a significant contributor to price 10 GovPX includes a Last Trade Side data item where it labels a trade as a Hit or a Take. 11 Evans (2002) and Evans and Lyons (2002) demonstrate the importance of order flow on exchange rates, where order flow is defined as the net of buyer-initiated and seller-initiated orders over a specified time interval. Brandt and Kavajecz (2004) examine price discovery in the U.S. Treasury market and find that order flow explains a large portion of the variation in yields. ...
When‐issued (i.e., forward) trading in T‐bills yet to be auctioned provides a unique environment for examining price discovery. Because T‐bills are auctioned in a sealed‐bid process, when‐issued traders cannot observe the spot market price. Yet the forward price must ultimately converge on the auction outcome price. Our results indicate that traders in the when‐issued market “discover” the ultimate auction price. Little evidence is found that standard order flow variables contribute to price discovery. Instead, the ability to observe a few trades with relatively small volume in the when‐issued market is sufficient to discover the auction price resulting from the sealed‐bid process.
... As an important preliminary to the analysis in the following sections, we present in Figure inter alia Evans, 2002;Ito and Hashimoto, 2006 and the references therein) which have recorded a similar intraday seasonality for major currencies. It is also worthwhile noting that the HKD/USD intraday seasonality follows closely the seasonality of USD/JPY spot prices because of its geographical proximity and similar trading times (Lyons et al., 1998;Ito and Hashimoto, 2006). ...
This paper studies covered interest parity arbitrage violations in foreign exchange markets and their relationship with market liquidity using a novel and unique dataset of tick-by-tick firm quotes for all financial instruments involved in the arbitrage strategy. The statistical analysis reveals that arbitrage opportunities are larger in size and slower to dissipate when market liquidity is poorer. Furthermore, their economic value is sizable but arbitrage profits only accrue to traders who are able to obtain low trading costs. These findings are consistent with a competitive equilibrium with real frictions when some traders have a comparative advantage in arbitrage trading.
... Finally, we include an AR (1) adjustment because we find evidence of serial correlation in price changes at short horizons in unreported results. This negative serial correlation is consistent with those found for equity price changes in Hasbrouck (1991) and foreign exchange price changes in Evans (2002). Table V presents the regression results for the 2-year, 5-year, and 10-year Treasury notes, using the 5-, 10-, and 30-minute sampling frequencies. ...
... In contrast, the empirical case that order flow has persistent impact on exchange rates is quite strong. For example, when interdealer order flow is measured precisely, it explains 40-80% of daily movements in major currency cross rates (Evans and Lyons 2002a,b). The word " daily " is important here: at the daily frequency , exchange rates are very nearly a martingale, as one would expect in a low friction speculative market. ...
We address four common misconceptions about micro-based research on exchange rates: (1) public news arrivals account for most exchange rate variation; (2) allocative trades do not convey information; (3) or-der flow is easy to measure; and (4) transactions obviously drive prices. Though few people subscribe to all four, most people subscribe to at least one. Dispelling these misconceptions should stimulate pro-gress in this area.
... More recently, variants of the order imbalance methodology have been used to analyse the foreign exchange and fixed income markets. Evans and Lyons (2002) and Evans (2002) provide evidence that order flow contains information about economic fundamentals, and so performs an important function that explains price movements. Pasquariello and Vega (2007) find that unanticipated order flow has a significant and permanent impact on daily bond yield changes, and correlation between order flow and price changes is higher when the dispersion of beliefs among market participants is high. ...
Order imbalance methodology is utilized to examine the link between trading activity and returns in the six most liquid international bond futures markets. Order imbalances are strongly related to contemporaneous returns, in the expected direction (i.e. excess buy (sell) orders push down (up) yields, even after controlling for aggregate market volume. There is evidence of contrarian investor behaviour following an increase in yields, but continuation of order imbalances when yields are falling (the prices of bond futures are rising). International bond futures markets are strongly intertwined with the US market having a strong influence on the returns and order-flow across all countries; this is likely an indication of the spill-over effect of US macroeconomic data.
... Under the interest rate parity condition, the hedged excess return is assumed to carry no risk premium, but empirical evidence suggests that the expected return on a hedged position has different risk premiums, depending on the regime of the economy (e.g., Evans (2002)). To accommodate that evidence, it is proposed that there is a common risk premium across currencies within each economic market regime. ...
We consider the presence of regimes in currency markets and their implications for interest rate parity. A weak form of interest rate parity is postulated and tested which assumes that the hedged risk premiums are identical within each regime across currencies. Both the in-sample (January 2002 - December 2004) and the out-of-sample (January 2005 - December 2007) daily data support weak interest rate parity. Furthermore, using the Federal Exchange Rate Index as a proxy of the currency market portfolio and T-Bills as the risk free asset, we find strong evidence that the weak interest rate parity hypothesis is consistent with standard portfolio equilibrium theory. The similarity between the benchmark and the implied equilibrium portfolio provides strong evidence that regime switching with weak interest rate parity is appropriate for modeling currency returns.
p>This thesis tackles two big questions. The first, from the macroeconomic literature is: what drives price? The second, from the market microstructure literature, is: what determines the bid-ask spread? The classification of these questions under these headings is conventional but is not strictly accurate. While macroeconomics has nothing to say about bid-ask spreads, market microstructure is concerned with price determination. Indeed, market microstructure views the two questions as so closely related that each is a linear function of the other in certain model settings. This duality arises because every transaction price differs from the mid-quote price by the amount of the half-spread. Since the price sequence itself is made up of a series of price innovations, it follows that the average price innovation consists of a half-spread and of mid-quote revisions due to public news releases which are assumed random. However, this relationship does not tell us why bid-ask spreads arise in the first place nor does it fully describe why prices change. Two additional factors which move prices are inventory and asymmetric information. Inventory describes the (usually temporary) imbalances between supply and demand which give rise to the bid-ask spread as a management cost but which nonetheless require price innovations (concessions) to be absorbed. Asymmetric information about future price innovations not only contributes to the bid-ask spreads because of adverse selection risk, but it also drives price. The remaining factor necessary to complete the picture of what determines prices and bid-ask spreads is termed ‘microstructure effects’. These include price discreteness and price clustering. It is a simple fact that prices are not continuous but instead move in discrete units and that some prices are used more frequently than others. For the first time, this thesis reveals the percentage contribution of asymmetric information, inventory and of price clustering to bid-ask spreads in the order-driven inter-dealer spot FX and short term interest rate futures markets. It also quantifies the respective contributions of news and inventory in shaping prices in these markets. Independently, it proves that asymmetric information could not be the dominant driver of prices or of the bid-ask spreads, in both markets. Finally, it shows that the level of asymmetric information in spot FX rates fell precipitously after EMU.</p
This paper provides a new test for whether different-currency assets are imperfect substitutes. The test exploits that under floating rates, changing public currency demand has no direct effect on monetary fundamentals, current or future. Price effects from imperfect substitutability are clearly present: the immediate price impact of public trades is 0.44 percent per 1 billion dollar (of which, about 80 percent persists indefinitely). This estimate is applicable to intervention trades in the special case when they are indistinguishable from private trades (i.e., when interventions are sterilized, anonymous, and provide no monetary-policy signal).
Research has shown that behavioral anomalies affect investors' choices and decisions in the financial markets. One such behavioral anomaly is feedback trading, a phenomenon wherein the investor uses past data to make future decisions. Using Sentana and Wadhwani's (1992) methodology, the 50 most liquid digital currencies (with the most extensive daily data reporting) were analyzed during the period 2013-2018. Results analysis suggests negative feedback trading in Tether Dollar and positive feedback trading in Bitcoin, Ethereum, CassinoCoin and ECC.
Diversos estudos apontam a presença de anomalias de mercado que desafiam explicações por meio das teorias clássicas de precificação, formação de portfólios e de eficiência de mercado. Uma destas anomalias comportamentais é o conhecido feedback trading, um efeito no qual o investidor utiliza dados passados para tomar decisões futuras. Por meio da metodologia de Santana e Wadhwani (1992), buscou-se analisar as 50 moedas digitais mais líquidas (com as maiores séries diárias de dados) no período de 04/2013 a 04/2018. Foi possível captar o feedback trading negativo nas moedas DigitalNote, Unobtanium e Riecoin e positivo nas moedas Bitcoin, Litecoin e Counterparty.
This article presents empirical test results of Malaysian foreign exchange market microstructure assessment of exchange rate dynamics. We apply vector autoregressive (VAR) model to estimate the influential role of currency order flow in the determination of the currency exchange rate for the Malaysian ringgit (MYR) against the US dollar (USD). We investigate whether currency order flow captures the movements of exchange rate of MYR against USD, and how the long-term and short-term components impact the relative estimation of MYR in the international market. We, construct a measure of order flow in the Malaysian foreign exchange market to reflect the pressure of currency excess demand. Our focus is on the cumulative currency order flow and the exchange rate relationship of MYR and USD. A hybrid model of order flow and exchange rate dynamics proposed by Evans and Lyons (2002a) is applied to the Malaysian foreign exchange market (MYR/USD) to analyse a dataset of every 15-minute currency order flow and exchange rate movements from January 2010 to December 2015. Our dataset has unique features in terms of the quality of the data, extensive period and precise high frequency. Our results show that currency order flow explains an important portion of the movements in the MYR–USD exchange rate.
Purpose
The essential role that currency order flow plays in the foreign exchange markets of emerging economies in the determination of their currencies in the short and the long-run against major currencies of the world cannot be over emphasized, most especially against the US dollar. Insomuch that, if some of these emerging economies can be successfully transmitted into full development, it would be a good model for other emerging economies and the world at large.
Design/methodology/approach
A hybrid model (Portfolio shift model) proposed by Evans and Lyons (2002) is extended to analyze a dataset of every quarter of an hour currency order flow and currency exchange rate fluctuations of Thai Baht (THB) against the US dollar for the period of six years (Jan. 2010 to Dec. 2015). To reflect the pressure of currency excess demand, we construct a measure of currency order flow in the Thailand currency exchange market. Vector Autoregression Model is applied to estimate the effectual role of currency order flow in the determination of exchange rate for the Thai Baht (THB) against the US dollar (USD).
Findings
Currency order flow indeed accounted for a sizeable and significant portion of the fluctuations in the THB and the USD exchange rate
Originality/value
Insomuch that, the results show that currency order flow has significant explanatory power in the emerging markets economy to capture the Thai Baht exchange rate variability, it then brings to the attention of the Thailand Monetary Authority the importance that should be attached to the market microstructure. Key words: currency exchange market, currency order flow, currency exchange rate, market microstructure
This article reviews the major developments in the recent literature on exchange rate economics. It is argued that the link between the exchange rate and economic fundamentals is breaking new ground. Evidence indicates that alternative analytical frameworks (such as the new open-economy macroeconomics) and exchange rate arrangements (such as the euro) have their theoretical and analytical elegance, but are proving empirically very difficult to implement. The role of methodological advances and alternative fundamental instruments (such as world commodity prices) is also highlighted.
The vast empirical failure of standard macro exchange rate determination models in explaining exchange rate movements motivates the development of microstructure approach to exchange rates in the 1990s. The microstructure approach of incorporating “order flow” in empirical models has gained considerable popularity in recent years, since its superior performance to macro exchange rate models in explaining exchange rate behavior. It is shown that order flow can explain about 60 percent of exchange rate movements versus 10percent at most in standard exchange rate empirical models. As the microstructure approach to exchange rates is an active ongoing research area, this chapter briefly discusses key concepts that constitute the approach.
The vast empirical failure of standard macro exchange rate determination models in explaining exchange rate movements motivates the development of microstructure approach to exchange rates in the 1990s. The microstructure approach of incorporating “order flow” in empirical models has gained considerable popularity in recent years, since its superior performance to macro exchange rate models in explaining exchange rate behavior. It is shown that order flow can explain about 60 % of exchange rate movements versus 60 % at most in standard exchange rate empirical models. As the microstructure approach to exchange rates is an active ongoing research area, this chapter briefly discusses key concepts that constitute the approach.
This paper addresses the optimal active versus passive portfolio mix in a straightforward
extension of the Treynor and Black (T-B) classic model. Such a model allows fund managers
to select the mix of active and passive portfolio that maximizes the (active) Sharpe ratio
performance indicator. The T-B model, here adapted and made operational as a tool for
performance measurement, enables one to identify the sources of fund management
performance (selectivity vs market-timing). In addition, the combination of active and passive
risk exposures is estimated and fund manager choice is tested against the hypothesis of
optimal (active) portfolio design.
The extended T-B model is applied to a sample of US dollar reserve management portfolios
– owned by the ECB and managed by NCBs – invested in high-grade dollar denominated
bonds. The best fund managers show statistically significant outperformance against the
ECB-given benchmark. By far, market timing is the main driver. Positive (and statistically
significant) selectivity appears to be very modest and relatively rare across fund managers.
These results are not very surprising, in that low credit risk and highly liquid securities
dominate portfolio selection, thus limiting the sources of profitable bond-picking activity. As
far as the risk-return profile of the active portfolio is concerned, it appears that some of the
best fund managers’ outperformance is realised by shorting the active portfolio (with respect
to the benchmark composition). Thus, portfolios that would be inefficient (eg negative excess
return) if held long can be turned into positive-alpha yielding portfolios if shorted. The ability
to select long-vs-short active portfolio can be seen as an additional source of fund manager’s
outperformance, beyond the skill in anticipating the return of the benchmark portfolio
(market-timing contribution).
The estimated measure of fund managers’ risk aversion turns out to be relatively high. This
seems to be consistent with the fairly conservative risk-return profile of the benchmark
portfolio. A relative measure of risk exposure (conditional Relative VaR) averaged across
fund managers turns out to be in line with the actual risk budget limit assigned by the ECB.
However, a fair amount of heterogeneity across fund managers is also found to be present.
This is likely to signal a less-than-efficient use of their risk-budget by the fund managers –
eg a deviation from the optimal level of relative risk accounted for by the model. At least in
part, such variability might also be attributed to estimation errors. However, proper tests for
RVaR statistics are sorely lacking in the risk management literature. Thus, the question
remains open. This would warrant further investigation, which is left for future research.
The paper provides empirical evidence of how a change in the monetary policy regime in South Africa has affected the anchorage of the exchange rate to fundamental determinants. Seeking to secure economic stabilization, South Africa has until 2000 devoted significant attention to stabilizing measures in the domestic foreign exchange market through a myriad of changes to its exchange rate regime and the macroeconomic landscape. In 2000, the country changed its monetary policy regime to inflation targeting. This new policy regime was expected to anchor market expectations to pricing the currency based on economic fundamentals, since it stabilizes interest rates by making them more predictable. However, the rand has sustained a long swing of decline in its exchange rate value that reversed in 2002 for a short while; resuming the swing in 2006. The paper explores whether then the monetary policy regime change did matter for the rand's pricing? Drawing on the asset approach to exchange rate determination, it uses a systems approach that combines Johansen's (1995) multivariate cointegration technique with the long run structural modeling approach of Persaran, Shin, and Smith (2002) and finds that economic fundamentals indeed anchor the rand's long swing. However, the anchorage is regime dependent; the policy regime shift to inflation targeting appears to have significantly altered the role and importance of economic fundamentals in pricing the rand. The results lend empirical support to the ongoing debate – the bipolar hypothesis (Fischer, 2008, 2001; Frankel, 1999) – on the suitability of exchange rate regimes for middle-income countries with wide exposure to international capital such as South Africa. The message of this study is that policy regime change matters a lot for currency pricing.
This paper examines the behavior of volatility and trading volume in an extended Mixture-of-Distribution Hypothesis framework. According to this Hypothesis, both volatility and volume are subordinated to the same latent, stochastic variable: the information flow. One way to enlarge this modeling in order to capture long range dependecies observed in these two variables is to use multi-component volatility models. However, traditional multi-component volatility models seem no longer enough to describe the more complex behavior of the volatility. This is why we introduce in this class of models, a stochastic cascade model of volatility, inherited from the multifractal paradigm. In the empirical section we provide some evidence in favor of this approach. Both volatility and volume are fractionally integrated processes with similar hyperbolic decay rates, but the long range dependence of their power transforms exhibits significant differences. Moreover, we emphasize the existence of lagged cross-correlations between the volatilities at different sampling frequencies, first pointed out by Müller et al. [59], which historically opened the door to a (stochastic) cascade scheme of the volatility in the literature. A multiscaling analysis of the structure functions (generalized volatilities) confirms this result. The empirical results are provided with data on the French stock Alcatel.
We study the risk of informed trading in an electronic foreign exchange market and test whether informed trading is driven by marketwide private information. Our framework is based on a structural microstructure trade model that measures the market makers' beliefs directly. Evidence of high concentration of informed trades is found to be inversely related to the overall 24-hour trading activity, i.e., early morning and late afternoon GMT rounds of trading involve the highest risk of informed trading. We structurally identify that the trades due to region-specific private information are dominant and explain between 5 and 25% of the variation in currency returns. In contrast, marketwide private information explains only about 1–5% of the variation in returns.
This paper presents a dynamic model of optimal currency returns with a hidden Markov regime switching process. We postulate a weak form of interest rate parity that the hedged risk premiums on currency investments are identical within each regime across all currencies. Both the in-sample and the out-of-sample data during January 2002 - March 2005 strongly support this hypothesis. Observing past asset returns, investors infer the prevailing regime of the economy and determine the most likely future direction to facilitate portfolio decisions. Using standard mean variance analysis, we find that an optimal portfolio resembles the Federal Exchange Rate Index which characterizes the strength of the U.S. dollar against world major currencies. The similarity provides a strong implication that our three-regime switching modelis appropriate for modeling the hedged returns in excess of the U.S. risk free interest rate. To investigate the impact of the equity market performance on changes of exchange rates, we include the S&P500 index return as an exogenous factor for parameter estimation.
This paper addresses the future of the foreign exchange market using two orga-nizing (and provocative) ideas. One pertains to the market's institutional struc-ture, the other to its information structure. The first organizing idea is that the structure of currency markets is driven primarily by the management of credit risk. This contrasts with drivers identified by microstructure theory (such as management of market risk, attenuation of asymmetric information, and entry barriers). The second organizing idea is that price variation in spot currency markets is driven primarily by dispersed information. This too contrasts with the orthodox view, under which exchange rates are determined from public in-formation. Though provocative, these two ideas are vital to understanding this market's future. Based on drivers of the market's current structure, I propose three scenarios for future evolution. The scenario I consider most likely is one in which the current dealer structure is maintained through dealing banks' cross-subsidizing their liquidity provision using gains from superior order flow infor-mation.
Evans and Lyons (1999) find that order flow accounts for about two-thirds of varia-tion in the DM/$ rate. Though never tested, the underlying cause of order flow in their model is portfolio shifts unrelated to macroeconomic information (e.g., shifts in risk preferences or shifts in hedging demands). This paper tests whether order flow is caused (in part) by macroeconomic information. Using a two-equation system— one for price and one for order flow—we examine the links between order flow and macro announcements. We find empirical support for the macro-information chan-nel: about one-third of variation in order flow is due to macro announcements. For prices, this implies that about 20 percent of price variation is due to announcement-induced order flow. Another 10 percent of price variation is due to the direct effect of announcements on price (i.e., not involving order flow).
This paper investigates the impact of public information arrivals on the mean and variance of stock price changes via order submission and execution. The Australian Securities Exchange, with a continuous disclosure regime that releases centrally time-stamped company announcements, provides us with a unique proxy for public information for our analysis. With the mean effect, we document that the order flows are informative on short-term stock returns, especially that the slope of the demand curve over the supply curve of the order book could predict the direction of stock price changes, and that public information arrivals increase the informativeness of the order flows. With the variance effect, we find that the relation between price volatility and trading volume and that between price volatility and the slope of the order book are strengthened as the intensity of public information arrivals increases. Overall, our findings contribute to the literature by providing new evidence that the order book conveys information about both direction and magnitude of stock price changes, and that public information arrivals induce heterogeneous revision of beliefs among market participants.
Share turnover has increased dramatically over the past several years. We explore possible causes. Higher turnover is associated with more frequent smaller orders, which have progressively formed a larger fraction of trading volume over time. However, institutions seem also to be contributing because share turnover has increased the most for stocks with the greatest level of institutional holdings. Changes in tick size can explain some but not all of the turnover increase. The increase in turnover does not appear to have been accompanied by greater production of private information. Some of the volume increase appears to be driven by enhanced sensitivity of turnover to past returns, perhaps revealing a more widespread use of quantitative trading strategies.
This paper addresses international financial integration in a new way. Past work on integration focuses either on speculative integration or on geographic integration. Our analysis focuses instead on informational integration. We de-velop a multi-currency model of portfolio allocation in the presence of dispersed information (therein making our definition of informational integration precise). We then test the model's implications using four months of concurrent transac-tion data on nine major currencies (each of which floats against the US dollar). The model explains 45 to 78 percent of daily returns in all nine currencies. Moreover, the model's prediction that order flow information should be relevant for determining prices in multiple markets is borne out. Two currencies in par-ticular exhibit substantial informational relevance in other markets: the Ger-man Mark and the Swiss Franc. This is in keeping with recent empirical re-sults on information geography (8 of our 9 currencies are European). Finally, we find that order flow information accounts on average for about 80 percent of the (high) unconditional covariance in currency returns. This suggests that cur-rency return covariance is not due to common public news, as traditionally modeled, but is instead due primarily to market aggregation of dispersed infor-mation.
Exchange rate is quoted by dealers based on the order flow they receive. Market survey and FX market microstructure literature suggest that financial customers order flow is the most informative and leads total order flow. This paper explains exchange rate dynamics by linking financial customers FX order flow with their dynamic portfolio allocation among domestic and foreign assets. Specifically, for any currency pair in a particular period, one currency has relatively higher assets return than the other and can be considered as high-return currency (HRC). Profit-seeking financial customers would hold more (less) HRC assets if their returns are expected to increase (decrease). Such portfolio reallocation generates positive (negative) order flow for the HRC and the currency appreciates (depreciates). Meanwhile, holding HRC assets is risky because of exchange rate fluctuations and higher volatility associated with high-return assets. Everything else equal, when financial customers become more risk-loving (risk-aversion), they would hold more (less) HRC assets, which causes positive (negative) order flow toward the HRC and the currency appreciates (depreciates). Thus, value of high-return currency (low-return currency) is positively (negatively) driven by expected returns of HRC assets and investors' risk appetite. The entire exchange rate dynamics is thus based directly on the financial market structure as opposed to traditional macroeconomic variables. As switch can occur in HRC status, business cycle and dominating factor, the direction that related financial variables affect exchange rate varies in different regimes. The paper finds country-specific period-specific supportive evidence for all major currencies in a long time period.
This paper presents stylized facts concerning the spot intra-daily foreign exchange markets. It first describes intra-daily data and proposes a set of definitions for the variables of interest. Empirical regularities of the foreign exchange intra-daily data are then grouped under three major topics: the distribution of price changes, the process of price formation and the heterogeneous structure of the market. The stylized facts surveyed in this paper shed new light on the market structure that appears composed of heterogeneous agents. It also poses several challenges such as the definition of price and of the time-scale, the concepts of risk and efficiency, the modeling of the markets and the learning process.
Matching university places to students is not as clear cut or as straightforward as it ought to be. By investigating the matching algorithm used by the German central clearinghouse for university admissions in medicine and related subjects, we show that a procedure designed to give an advantage to students with excellent school grades actually harms them. The reason is that the three-step process employed by the clearinghouse is a complicated mechanism in which many students fail to grasp the strategic aspects involved. The mechanism is based on quotas and consists of three procedures that are administered sequentially, one for each quota. Using the complete data set of the central clearinghouse, we show that the matching can be improved for around 20% of the excellent students while making a relatively small percentage of all other students worse off.
The paper utilized foreign exchange data (bid, ask and transaction prices and quantities) collected from the screen of the electronic broking system (Reuter D2000-2) on June 16, 1993. The bid and ask quotes, which are `firm' in this data set, are compared with the Reuters FXFX page, which reports only indicative bid and ask prices. A caution is necessary due to its small samples (7 hours). The paper finds that although the bid-ask mean of indicative quotes is similar to that of `firm' quotes, the behavior of bid-ask spread and the frequency of quote entry are quite different in the two kinds of quotes. The bid-ask spreads in the broking system are much more time- variant and dependent on the frequency of trade, while the indicative bid-ask spreads tend to cluster at round numbers.
This chapter presents a critical survey and an interpretation of recent exchange rate research. It focuses on empirical results for exchange rates among major industrialized countries. The expectations of future exchange rate changes are a key determinant of asset demands, and therefore of the current exchange rate. The expectations variable is relatively straightforward in the conventional monetary models; in theoretical terms , it is determined by the rational expectations assumption, while in empirical terms, it is typically measured by the forward discount or interest differential. The standard empirical implementation of rational expectations methodology infers ex ante expectations of investors from ex post changes in the exchange rate. Unexpected changes in monetary policy frequently cause movements in the exchange rate in the direction hypothesized by the sticky-price monetary model. The chapter presents a survey of the work on exchange rate determination in floating rate regimes. It considers evidence across exchange rate regimes and examines the issue of speculative bubbles. It also reviews some relatively new directions in exchange rate research that focus on the micro-structure of foreign exchange markets.
The paper uses an intertemporal mean-variance model of the market for a dividend-paying risky asset to analyse rational expectations equilibria when all agents condition their expectations on past rather than current prices. The main result shows that if the time span between successive market periods is short, the market will approximate full informational efficiency arbitrarily closely, yet the returns to being informed are bounded away from zero. This contrasts with the Grossman-Stiglitz proposition that markets cannot come close to informational efficiency if the acquisition of information is costly.
We report some findings from a survey of practitioners in the interbank foreign exchange markets in Hong Kong, Tokyo, and Singapore. The respondents contend that liquidity and market uncertainty are two important reasons for deviating from the conventional interbank bid-ask spread. A strong customer base is perceived as a source of competitive advantage for large participants.Most respondents agree that non-fundamental factors have pervasive impacts on short-run exchange rates. Speculation is believed to increase volatility but also improve market liquidity and efficiency. Despite their claim that intervention exacerbates volatility, more than one-half of the respondents suggest official intervention helps restore equilibrium.
We identify a period with a high concentration of informed yen/dollar traders active in Tokyo. Findings include:1.Japanese quotes lead the rest of the market when the informed are active. At other times, two-way causality is observed in quotes.2.The contribution of Japanese quotes to yen/dollar price discovery relative to quotes of the rest-of-the-world is 5 to 12 percentage points higher when the informed are active compared to when they are absent.Private information can, at times, be important, yet “normal” times are characterized as periods where public information results in a high contemporaneous correlation across quotes.
Consistent with the implications from a simple asymmetric information model for the bid-ask spread, we present empirical evidence that the size of the bid-ask spread in the foreign exchange market is positively related to the underlying exchange rate uncertainty. The estimation results are based on an ordered probit analysis that captures the discreteness in the spread distribution, with the uncertainty of the spot exchange rate being quantified through a GARCH type model. The data sets consist of more than 300,000 continuously recorded Deutschemark/dollar quotes over the period from April 1989 to June 1989.
This paper develops a model of international equity portfolio investment flows based on differences in informational endowments between foreign and domestic investors. It is shown that when domestic investors possess a cumulative informati on advantage over foreign investors about their domestic market, investors tend to purchase foreign assets in periods when the return on foreign assets is high and to sell when the return is low. The implications of the model are tested using data on US equity portfolio flows.
This paper analyzes hourly data for four foreign exchange spot rates, deutsche mark/dollar, British pound/dollar, Yen/dollar, and Swiss franc/dollar, with a series covering January-July 1986 involving 3,409 observations. Besides standard findings of leptokurtosis and unit roots, three of the series exhibit negative first-order autocorrelation that became more pronounced after jumps. The series are pair-wise cointegrated and la gs of the deutsche mark/dollar helped in forecasting the Swiss franc/dollar. There is a marked hourly pattern in foreign exchange volatility, with much of the weekend break effect occurring only after Europe reopens at 09.00 Greenwich mean time on Monday mornings. Copyright 1993 by Blackwell Publishers Ltd and The Victoria University of Manchester
This paper provides a detailed characterization of the volatility in the deutsche mark-dollar foreign exchange market using an annual sample of five-minute returns. The approach captures the intraday activity patterns, the macroeconomic announcements, and the volatility persistence (ARCH) known from daily returns. The different features are separately quantified and shown to account for a substantial fraction of return variability, both at the intraday and daily level. The implications of the results for the interpretation of the fundamental "driving forces" behind the volatility process is also discussed. Copyright The American Finance Association 1998.
The behavior of quote arrivals and bid-ask spreads is examined for continuously recorded deutsche mark-dollar exchange rate data over time, across locations, and by market participants. A pattern in the intraday spread and intensity of market activity over time is uncovered and related to theories of trading patterns. Models for the conditional mean and variance of returns and bid-ask spreads indicate volatility clustering at high frequencies. The proposition that trading intensity has an independent effect on returns volatility is rejected but holds for spread volatility. Conditional returns volatility is increasing in the size of the spread. Copyright 1993 by American Finance Association.
Many economic models yield the prediction that the unobservable conditional expectations of two series are perfectly correlated. In this paper, we propose an informative method for investigating this prediction. The method involves examining the sample correlation coefficient for the fitted values from unrestricted ordinary least squares regressions, and the estimated standard error and confidence interval of this correlation coefficient. The method is designed to supplement existing statistical tests, which are often uninformative about the exact nature in which the data agree or disagree with the prediction of perfect correlation. We also apply our method to three distinct models and data sets.
This paper studies estimators that make sample analogues of population orthogonality conditions close to zero. Strong consistency and asymptotic normality of such estimators is established under the assumption that the observable variables are stationary and ergodic. Since many linear and nonlinear econometric estimators reside within the class of estimators studied in this paper, a convenient summary of the large sample properties of these estimators, including some whose large sample properties have not heretofore been discussed, is provided.
This paper seeks to explain the causes of volatility clustering in exchange rates. Careful examination of intra-daily exchange rates provides a test of two hypotheses--heat waves and meteor showers. The heat wave hypothesis is that the volatility in one market is predicted only by the past of that market. The meteor shower hypothesis is that intra-daily volatility spills over from one market to the next. Using the GARCH model to specify the heteroskedasticity across intra-daily market segments, we find that the empirical evidence is generally against the null hypothesis of the heat wave. Using a volatility type of vector autoregression we examine the impact of news in one market on the time path of per-hour volatility in other markets. Copyright 1990 by The Econometric Society.
This paper suggests that the interactions of security trades and quote revisions be modeled as a vector autoregressive system. Within this framework, a trade's information effect may be meaningfully measured as the ultimate price impact of the trade innovation. Estimates for a sample of NYSE issues suggest a trade's full price impact arrives only with a protracted lag; the impact is a positive and concave function of the trade size; large trades cause the spread to widen; trades occurring in the face of wide spreads have larger price impacts; and information asymmetries are more significant for smaller firms. Copyright 1991 by American Finance Association.
In this paper I develop a theory of bid-ask quotes provided by foreign exchange dealers in the inter-bank market based on their beliefs and their inventory positions. I then build an agent-based model of the inter-dealer market where dealers learn in a Bayesian manner from quotes from other dealers. Using simulations, I find that the resulting intra-day spreads and between-quotes returns largely conform to the empirically observed intra-day U-shaped pattern -- a feature that has not been satisfactorily explained in the literature. I also study the factors that determine this U-shape. JEL Classification: D83, F31 Key Words: Agent based model, foreign exchange, microstructure + This paper has benefited immensely from the numerous suggestions and continuous guidance from my advisor Richard Roll. Avanidhar Subrahmanyam, Peter Schott and the participants at conferences at UCLA, University of Notre-Dame and University of Alberta have also provided valuable suggestions. All remaining blemish...
Measuring the information content of stock tradesModeling market microstructure time series”, The Handbook of Statistics
- J Hasbrouck
- J Rhasbrouck
Hasbrouck, J., 1991, “Measuring the information content of stock trades”, Journal of Finance 41(1), 179-202. 39 rHasbrouck, J., 1998, “Modeling market microstructure time series”, The Handbook of Statistics, vol. 14, Maddala and Rao eds. North Holland
Investigating the Correlation of Unobserved Expectations: Expected Returns in Equity and Foreign Exchange Markets and Other Examples
- R Cumby
- J Huizinga
Cumby, R. and J. Huizinga, 1993, " Investigating the Correlation of Unobserved Expectations:
Expected Returns in Equity and Foreign Exchange Markets and Other Examples, Journal of
Monetary Economics, January.
The Microstructure of Foreign Exchange Dynamics " typescript, Georgetown University , presented at the NBER Market Microstructure Conference
- M Evans
Evans, M., " The Microstructure of Foreign Exchange Dynamics " typescript, Georgetown University, presented at the NBER Market Microstructure Conference, December 4 1997.
Order ßow and Exchange Rate Dynamics " NBER working paper no
- M Evans
- R Lyons
Evans, M., and R.Lyons, 1999, " Order ßow and Exchange Rate Dynamics " NBER working paper
no. 7317, August.
live: Impact of new trading environments
- G Bjonnes
- D Rime
Bjonnes, G., and D. Rime, 1998, " FX Trading... live: Impact of new trading environments ",
typescript, Norwegian School of Management, December.