Working Paper: CEPR ID: DP16128
Authors: Giovanni Cespa; Antonio Gargano; Steven Riddiough; Lucio Sarno
Abstract: We investigate the information contained in foreign exchange (FX) volume using a novel dataset from the over-the-counter market. We find that volume helps predict next day currency returns and is economically valuable for currency investors. Predictability implies a stronger currency return reversal for currency pairs with abnormally low volume today, and is driven by the component of FX volume unrelated to volatility, illiquidity, and order flow. We rationalize these findings via a simple model of exchange rate determination, in which volume helps reveal the degree of asymmetric information in currency markets. Testing this prediction shows that asymmetric information is uniform acrosscurrency pairs but varies across instruments.
Keywords: foreign exchange volume; currency returns; asymmetric information
JEL Codes: G12; G14; G15; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| FX volume (F31) | next-day currency returns (F31) |
| abnormally low volume today (G14) | stronger currency return reversal (F31) |
| increase in asymmetric information (D82) | weakening of return reversal dynamic (C22) |
| demand for foreign bonds (FX volume) (G15) | currency returns (F31) |
| FX volume unrelated to volatility, illiquidity, and order flow (G15) | predictability of currency returns (F31) |
| FX volume (F31) | degree of asymmetric information (D82) |
| FX volume (spot and forward market) (G15) | privately informed trading (G14) |