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The currency that came in from the cold: Capital controls and the information content of order flow

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  • Breedon, Francis
  • Pétursson, Thórarinn G.
  • Vitale, Paolo

Abstract

We analyse how capital controls affect FX microstructure, using as a case study the introduction and subsequent removal of controls in Iceland. We use a VAR of private order flow, Central Bank order flow and EURISK that allows for contemporaneous feedback effects to analyse the impact and information content of trades and find that controls have profound effects. When controls were introduced, volume plummeted, the information content of trading activity declined and became less responsive to macro news. While there was no recovery of trading volume after controls were abolished, the information content and responsiveness of trading activity increased sharply.

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  • Breedon, Francis & Pétursson, Thórarinn G. & Vitale, Paolo, 2023. "The currency that came in from the cold: Capital controls and the information content of order flow," Journal of International Money and Finance, Elsevier, vol. 138(C).
    • Handle: RePEc:eee:jimfin:v:138:y:2023:i:c:s0261560623001468
    DOI: 10.1016/j.jimonfin.2023.102945
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    Cited by:

    1. Stefán Thórarinsson, 2022. "Analysing inflation dynamics in Iceland using a Bayesian structural vector autoregression model," Economics wp88, Department of Economics, Central bank of Iceland.

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    More about this item

    Keywords

    Exchange rates; Order flow; Market microstructure; Capital controls;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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