Private Information, Stock Markets, and Exchange Rates

Abstract

The determination of exchange rates has long been an important but vexatious topic in international finance and economics. The recent exchange rate literature has demonstrated that exchange rates are determined importantly by investors' private information, and that macroeconomic data and other public information items play a comparatively minor role once order flow, which conveys private information to the market, is incorporated in the models. We define order flow as the difference between the volume of buyer-and seller-initiated trades in a financial market. 6In recent years, economists have become increasingly aware that not all components of order flow in foreign exchange (FX) markets are equally important; some components matter far more for price formation than others. Progress on identifying which order flow components convey the most private information has been slowed by the fact that private information is, by its nature, rarely observed directly. In this paper, we propose and provide strong empirical evidence for the view that the private information of relevance for exchange rate determination is associated far more with stock markets than with other financial markets, such as government bond markets.Our view is consistent with three main findings reported in the literature regarding the importance of various types of order flow for the exchange rate; see Osler (2008, pp 30f) for an overview. The first finding is that customer order flow carries more information than interdealer order flow. The second related finding is that financial customer order flow carries more information than commercial customer order flow. The third finding is that order flow driven by leveraged investors carries more private information than other institutional investor order flow does. Thus, our view is also consistent with empirical claims that (i) FX market order flow related to equity market transactions to a large extent tends to be initiated by leveraged financial-sector customers and (ii) FX market order flow related to bond market 1 The authors wish to thank Eli Remolona for detailed discussions and thorough critiques of earlier versions of this paper. We are grateful for comments

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“…Therefore, (stationary) measurement errors in EDFs cannot explain our finding that EDFs and CDS rates are not cointegrated. Inference issues arising in models in which observed variables contain I(1) measurement error components are examined in more detail in Gyntelberg et al (2009). may give rise to this problem.…”

Private Information, Capital Flows, and Exchange Rates

“…18 For empirical tests using the individual FX series, see Gyntelberg et al (2009). 19 If each transaction record submitted by the FX dealing banks to the BoT contained information to denote whether the customer's FX transaction was associated with a transaction in (i) the domestic stock market, (ii) the bond market, or (iii) neither of the above, it would of course be straightforward to test our hypothesis directly: One would run an order flow regression with FX returns as the dependent variable and the three FX order flow series as regressors.…”

“…Additional characterizations of the datasets and further descriptive statistics are given inGyntelberg et al (2009) andGyntelberg et al (2014).4 The NRBA regulations relevant for our study went into effect in Oct. 2004, i.e., just before the start of the sample period.…”

Private Information, Capital Flows, and Exchange Rates

“…18 For empirical tests using the individual FX series, see Gyntelberg et al (2009). 19 If each transaction record submitted by the FX dealing banks to the BoT contained information to denote whether the customer's FX transaction was associated with a transaction in (i) the domestic stock market, (ii) the bond market, or (iii) neither of the above, it would of course be straightforward to test our hypothesis directly: One would run an order flow regression with FX returns as the dependent variable and the three FX order flow series as regressors.…”