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Tests of microstructural hypotheses in the foreign exchange market

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  • Lyons, Richard K.

Abstract

This paper introduces a three-part transactions dataset to test various microstructural hypotheses about the spot foreign exchange market. In particular, we test for effects of trading volume on quoted prices through the two channels stressed in the literature: the information channel and the inventory-control channel. We find that trades have both a strong information effect and a strong inventory-control effect, providing support for both strands of microstructure theory. The bulk of equity-market studies also find an information effect; however, these studies typically interpret this as evidence of inside information. Since there are no insiders in the foreign exchange market, this finding suggests a broader conception of the information environment, at least in this context.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 39 (1995)
Issue (Month): 2-3 ()
Pages: 321-351

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Handle: RePEc:eee:jfinec:v:39:y:1995:i:2-3:p:321-351

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Web page: http://www.elsevier.com/locate/inca/505576

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  2. Bessembinder, Hendrik, 1994. "Bid-ask spreads in the interbank foreign exchange markets," Journal of Financial Economics, Elsevier, vol. 35(3), pages 317-348, June.
  3. Hasbrouck, Joel, 1988. "Trades, quotes, inventories, and information," Journal of Financial Economics, Elsevier, vol. 22(2), pages 229-252, December.
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  8. Madhavan, Ananth & Smidt, Seymour, 1993. " An Analysis of Changes in Specialist Inventories and Quotations," Journal of Finance, American Finance Association, vol. 48(5), pages 1595-1628, December.
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  13. Charles Goodhart, 1990. "News and the Foreign Exchange Market," FMG Discussion Papers dp71, Financial Markets Group.
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  17. Garman, Mark B., 1976. "Market microstructure," Journal of Financial Economics, Elsevier, vol. 3(3), pages 257-275, June.
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  19. Roell, Ailsa, 1990. "Dual-capacity trading and the quality of the market," Journal of Financial Intermediation, Elsevier, vol. 1(2), pages 105-124, June.
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  22. Zabel, Edward, 1981. "Competitive Price Adjustment without Market Clearing," Econometrica, Econometric Society, vol. 49(5), pages 1201-21, September.
  23. Manaster, Steven & Mann, Steven C, 1996. "Life in the Pits: Competitive Market Making and Inventory Control," Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 953-75.
  24. Admati, Anat R & Pfleiderer, Paul, 1989. "Divide and Conquer: A Theory of Intraday and Day-of-the-Week Mean Effects," Review of Financial Studies, Society for Financial Studies, vol. 2(2), pages 189-223.
  25. Bollerslev, Tim & Domowitz, Ian, 1993. " Trading Patterns and Prices in the Interbank Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 48(4), pages 1421-43, September.
  26. Flood, Mark D., 1994. "Market structure and inefficiency in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 13(2), pages 131-158, April.
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