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What are the Origins of Foreign Exchange Movements?

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Abstract

This paper uses a new transactions data set on the inter bank foreign exchange market to examine the origins of spot exchange rate movements. The data provide a comprehensive picture of trading activity and allow me to examine the contribution of public news to spot rate dynamics over hours, days, and weeks. Contrary the presumption of macroeconomic exchange rates models, I find that public news only accounts for a fraction of exchange rate volatility over the whole frequency spectrum. In particular, I estimate that less that 50\% of the variance of spot rate changes at very high frequencies is attributable to public news. At daily and weekly frequencies, changes in the spot rate understate the effects of public news by 20 to 40 percent because the cumulative effects of independent public and private news exert offsetting effects. These findings suggest one reason for the poor performance of macroeconomic exchange rate models; namely their exclusive focus on public Classification-JEL Codes:

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Paper provided by Georgetown University, Department of Economics in its series Working Papers with number gueconwpa~05-05-06.

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Date of creation: 06 May 2005
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Handle: RePEc:geo:guwopa:gueconwpa~05-05-06

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Postal: Georgetown University Department of Economics Washington, DC 20057-1036
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Postal: Marcia Suss Administrative Officer Georgetown University Department of Economics Washington, DC 20057-1036
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Web: http://econ.georgetown.edu/

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  1. Takatoshi Ito & Richard K. Lyons & Michael T. Melvin, 1998. "Is There Private Information in the FX Market? The Tokyo Experiment," Journal of Finance, American Finance Association, vol. 53(3), pages 1111-1130, 06.
  2. Charles Goodhart & Takatoshi Ito & Richard Payne, 1995. "One Day in June, 1994: A Study of the Working of Reuters 2000-2 Electronic Foreign Exchange Trading System," NBER Technical Working Papers 0179, National Bureau of Economic Research, Inc.
  3. Baillie, R.T. & Bollerslev, T., 1989. "Intra Day And Inter Market Volatility In Foreign Exchange Rates," Papers 8811, Michigan State - Econometrics and Economic Theory.
  4. Covrig, Vicentiu & Melvin, Michael, 2002. "Asymmetric information and price discovery in the FX market: does Tokyo know more about the yen?," Journal of Empirical Finance, Elsevier, vol. 9(3), pages 271-285, August.
  5. 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.
  6. Michael J. Fleming & Eli M. Remolona, 1999. "Price Formation and Liquidity in the U.S. Treasury Market: The Response to Public Information," Journal of Finance, American Finance Association, vol. 54(5), pages 1901-1915, October.
  7. Beck, Stacie E., 1993. "The Ricardian equivalence proposition: evidence from foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 154-169, April.
  8. Richard B. Olsen & Ulrich A. Müller & Michel M. Dacorogna & Olivier V. Pictet & Rakhal R. Davé & Dominique M. Guillaume, 1997. "From the bird's eye to the microscope: A survey of new stylized facts of the intra-daily foreign exchange markets (*)," Finance and Stochastics, Springer, vol. 1(2), pages 95-129.
  9. Payne, Richard, 2003. "Informed trade in spot foreign exchange markets: an empirical investigation," Journal of International Economics, Elsevier, vol. 61(2), pages 307-329, December.
  10. Peiers, Bettina, 1997. " Informed Traders, Intervention, and Price Leadership: A Deeper View of the Microstructure of the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 52(4), pages 1589-1614, September.
  11. Cheung, Yin-Wong & Wong, Clement Yuk-Pang, 2000. "A survey of market practitioners' views on exchange rate dynamics," Journal of International Economics, Elsevier, vol. 51(2), pages 401-419, August.
  12. Takatoshi Ito & V. Vance Roley, 1986. "News from the U.S. and Japan: which moves the yen/dollar exchange rate?," Research Working Paper 86-02, Federal Reserve Bank of Kansas City.
  13. Ho, Thomas S Y & Stoll, Hans R, 1983. " The Dynamics of Dealer Markets under Competition," Journal of Finance, American Finance Association, vol. 38(4), pages 1053-74, September.
  14. Richard Payne, 1996. "Announcement Effects and Seasonality in the Intra-day Foreign Exchange Market," FMG Discussion Papers dp238, Financial Markets Group.
  15. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729 Elsevier.
  16. Hardouvelis, Gikas A., 1988. "Economic news, exchange rates and interest rates," Journal of International Money and Finance, Elsevier, vol. 7(1), pages 23-35, March.
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Cited by:
  1. Evans, Martin D. & Lyons, Richard K., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance, Working Paper Series qt0dh1c16w, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
  2. Kathryn M. Dominguez, 1999. "The Market Microstructure of Central Bank Intervention," NBER Working Papers 7337, National Bureau of Economic Research, Inc.
  3. Michael J. Fleming, 2003. "Measuring treasury market liquidity," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-108.

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