Working Paper: NBER ID: w9893
Authors: H. Henry Cao; Martin D. D. Evans; Richard K. Lyons
Abstract: In a market with symmetric information about fundamentals, can information-based trade still arise? Consider bond and FX markets, where private information about nominal cash flows is generally absent, but participants are convinced that superior information exists. We analyze a class of asymmetric information - inventory information - that is unrelated to fundamentals, but still forecasts future price (by forecasting future discount factors). Empirical work based on the analysis shows that inventory information in FX does indeed forecast discount factors, and does so over both short and long horizons. The immediate price impact of shocks to inventory information is large, roughly 50 percent of that from public information shocks (the latter being the whole story under symmetric information). Within about 30 minutes the transitory effect dies out, and prices reflect a permanent effect from inventory information that ranges between 15 and 30 percent of that from public information.
Keywords: Inventory Information; Market Dynamics; Foreign Exchange; Asymmetric Information
JEL Codes: G12; G14; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Inventory information (L81) | Future price forecasts (Q47) |
| Inventory information (L81) | Market prices (P22) |
| Inventory shocks (D25) | Immediate price impact (G14) |
| Immediate price impact (G14) | Permanent price impact (D41) |
| Positive shock to interdealer order flow (C69) | Currency price increase (F31) |
| Transitory effects from inventory information (D25) | Variance in price changes (E30) |