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Foreign Exchange Market Microstructure

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Author Info
Martin D. D. Evans (Georgetown University) () (Department of Economics, Georgetown University)

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Abstract

This paper provides an overview of the recent literature on Foreign Exchange Market Microstructure. Its aim is not to survey the literature, but rather to provide an introductory tour to the main theoretical ideas and empirical results. The central theoretical idea is that trading is an integral part of the process through which information relevant to the pricing of foreign currency becomes embedded in spot rates. Micro-based models study this information aggregation process and produce a rich set of empirical predictions that find strong support in the data. In particular, micro-based models can account for a large proportion of the daily variation in spot rates. They also supply a rationale for the apparent disconnect between spot rates and fundamentals. In terms of forecasting, micro-based models provide out-of-sample forecasting power for spot rates that is an order of magnitude above that usually found in exchange-rate models. Classification-JEL Codes: F3, F4, G1

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Paper provided by Georgetown University, Department of Economics in its series Working Papers with number gueconwpa~05-05-20.

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Handle: RePEc:geo:guwopa:gueconwpa~05-05-20

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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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Related research
Keywords: Exchange Rates; Microstructure; Information Aggregation; FX Trading.;

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References listed on IDEAS
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  1. 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. [Downloadable!] (restricted)
  2. Charles Engel & Kenneth D. West, 2005. "Exchange Rates and Fundamentals," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 485-517, June.
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  3. Martin D. D. Evans & Richard K. Lyons, 2003. "How is Macro News Transmitted to Exchange Rates?," NBER Working Papers 9433, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2003. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," American Economic Review, American Economic Association, vol. 93(1), pages 38-62, March. [Downloadable!]
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  5. C. L. Osler, 2002. "Stop-loss orders and price cascades in currency markets," Staff Reports 150, Federal Reserve Bank of New York. [Downloadable!]
  6. Osler, Carol L., 2005. "Stop-loss orders and price cascades in currency markets," Journal of International Money and Finance, Elsevier, vol. 24(2), pages 219-241, March. [Downloadable!] (restricted)
  7. Lyons, Richard K., 1997. "A simultaneous trade model of the foreign exchange hot potato," Journal of International Economics, Elsevier, vol. 42(3-4), pages 275-298, May. [Downloadable!] (restricted)
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