Informed trade in spot foreign exchange markets: an empirical investigation

Whose trades convey information? Evidence from a cross-section of traders

“…Huang and Stoll (1997) empirically decompose spreads in equity markets and show that bid ask spreads indeed cover order processing costs, inventory costs and rewards for adverse selection. Payne (2003) for order driven and Osler, Mende and Menkhoff (2006) for quote driven markets also find spreads to partially compensate for adverse selection in currency markets. Based on these earlier findings, we expect the spread at which traders place their orders to positively influence the overall price impact of orders.…”

“…In the model of Admati and Pfleiderer (1988) liquidity traders decide to trade together to guard against the informed. Therefore, one should expect to find a negative relation between the level of liquidity a trader prefers to trade at and his price impact (see Payne, 2003). However, as also discussed in Admati and Pfleiderer (1988), higher liquidity could attract informed traders attempting to trade at low costs.…”

“…Accordingly, most studies in this field circumvent the focus on traders and instead analyze trades. They observe the time-series dimension and find 1 For the information contained in order flow see for example Hasbrouck (1991Hasbrouck ( , 1991aHasbrouck ( , 2006, Dufour and Engle (2000) or Dunne, Hau and Moore (2004) on stock markets, Bozcuk and Lasfer (2005), Brandt and Kavajecz (2004), Green (2004) and Hautsch and Hess (2004) on bond markets and Ito, Lyons and Melvin (1998), Evans and Lyons (2002, 2002a, 2005, 2005a, Froot and Ramadorai (2005), Love and Payne (2003), Payne (2003) or Gehrig and Menkhoff (2004) on foreign exchange markets. 2 There are further approaches to analyze asymmetric information, such as comparing financial versus non-financial customer order flow (Lyons, 2001, Bjønnes, Rime andSolheim, 2005) or examining profitability of position taking of market participants with and without local proximity to firms' headquarters (e.g.…”

“…These characteristics are interpreted from the viewpoint of information processing, such that larger trade size or wider bid-ask spread convey information (Hasbrouck, 1991, Koski and Michaely, 2000, Hasbrouck and Seppi, 2001, Payne, 2003, Brandt and Kavajecz, 2004, Bjønnes and Rime, 2005.…”

An assessment of some open issues in the analysis of foreign exchange intervention

“…the imbalance between buyer-initiated and seller-initiated transactions, is an important determinant of exchange rate dynamics in the short and possibly even in the medium term. Indeed, empirical studies of the impact of order flow on exchange rates, notably Lyons (1995), Evans and Lyons (2002), Payne (2003) and Biønnes and Rime (2005), suggest that in FX markets order flow possesses an information content, as the impact of trade innovation on exchange rate is large, significant and persistent. There is also evidence, Evans and Lyons (2005), that order flow anticipates shifts in foreign exchange fundamentals.…”