Working Paper: CEPR ID: DP6553
Authors: Paolo Vitale
Abstract: We formulate a market microstructure model of exchange determination we employ to investigate the impact of informed trading on exchange rates and on foreign exchange (FX) market conditions. With our formulation we show how strategic informed agents influence exchange rates via both portfolio-balance and information effects. We outline the connection which exists between the private value of information, market efficiency, liquidity and exchange rate volatility. Our model is also consistent with recent empirical research on the microstructure of FX markets.
Keywords: exchange rate dynamics; foreign exchange microstructure; order flow; private information
JEL Codes: D82; G14; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| informed trading (G14) | exchange rates (F31) |
| order flow (C69) | exchange rates (F31) |
| informed trading (G14) | expected returns (G17) |
| order flow (C69) | expected returns (G17) |
| informed traders (G14) | market efficiency (G14) |
| market efficiency (G14) | exchange rates (F31) |
| order flow (C69) | uncertainty about future fundamental innovations (D89) |