Working Paper: NBER ID: w13151
Authors: Martin D. D. Evans; Richard K. Lyons
Abstract: We address whether transaction flows in foreign exchange markets convey fundamental information. Our GE model includes fundamental information that first manifests at the micro level and is not symmetrically observed by all agents. This produces foreign exchange transactions that play a central role in information aggregation, providing testable links between transaction flows, exchange rates, and future fundamentals. We test these links using data on all end-user currency trades received at Citibank over 6.5 years, a sample sufficiently long to analyze real-time forecasts at the quarterly horizon. The predictions are borne out in four empirical findings that define this paper's main contribution: (1) transaction flows forecast future macro variables such as output growth, money growth, and inflation, (2) transaction flows forecast these macro variables significantly better than the exchange rate does, (3) transaction flows (proprietary) forecast future exchange rates, and (4) the forecasted part of fundamentals is better at explaining exchange rates than standard measured fundamentals.
Keywords: Exchange Rates; Transaction Flows; Macroeconomic Fundamentals
JEL Codes: F31; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| transaction flows (F38) | output growth (O40) |
| transaction flows (F38) | money growth (O42) |
| transaction flows (F38) | inflation (E31) |
| transaction flows (F38) | exchange rates (F31) |
| transaction flows (F38) | macroeconomic fundamentals (E66) |
| transaction flows (F38) | future macro variables (E17) |