The role of asymmetric information among investors in the foreign exchange market

Abstract

This paper posits asymmetric information as the missing link between the currency demands of investors and changes in the exchange rate. A theoretical model demonstrates that changes in the exchange rate and currency demand are positively correlated for well-informed investors and negatively correlated for less well-informed investors, results consistent with stylized facts from the empirical literature. These theoretical findings are supported empirically using a new data set from the Israeli foreign exchange market. The empirical analysis indicates that a one million dollar larger purchase than sales by well-informed financial investors induces an increase of 0.060 per cent in the Israeli Sheqel|Dollar exchange rate over a one month period. A similar net flow from less well-informed investors results in a 0.046 per cent decrease in the exchange rate. Copyright © 2008 John Wiley & Sons, Ltd.

How Much You Know Matters: A Note on the Exchange Rate Disconnect Puzzle

“…Surprisingly, a shock to non-fundamentals has the biggest e¤ect on the exchange rate when the proportion of informed investors in the market is the smallest (10 percent). In other words, rational confusion is the biggest when the amount of aggregate information about future fundamentals in the economy is the lowest 8 .…”

“…The setup of the model follows from Onur (2008). It is a two-country monetary model of exchange rate determination with money market equilibrium, purchasing power parity and interest rate parity assumed.…”

Micro Approaches to Foreign Exchange Determination

“…This is indeed the case. Marsh and O'Rourke (2005) find such a result for major currencies, King, Sarno, and Sojli (2010), Bjønnes, Rime, and Solheim (2005), and Rime (2001) for small open economies, and Gyntelberg, Loretan, Subhanij, and Chan (2009), Onur (2008) and Wu (2007) for emerging markets.…”

Exchange Rate Forecasting with Information Flow Approach

“…Because foreign exchange market is organized as an OTC market, we were unable to find any research where the order flow data would be composed of all the transactions in the wholesale market. Lovcha, PerezLaborda (2010), Gradojevic (2007), Jalil, Feridun (2010), Onur (2008) used central banks' data in their studies, also data from trading Reuters, EBS trading platforms are used. Table 1 shows which part in transaction turnover belongs to the EBS trading platform.…”