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An Information Approach to International Currencies

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  • Richard K. Lyons
  • Michael J. Moore

Abstract

This paper addresses currency competition from an information perspective. Transactions in traditional models do not convey information, so transaction costs -- the driver of competition outcomes -- are driven by market size. In our model transactions do convey information (consistent with recent empirical findings). Several important departures arise. First, adding the information dimension resolves the traditional indeterminacy of currency trade patterns (by mitigating the concentrating force of market-size economies). Second, whether transactions are executed directly or through a vehicle actually affects prices (because these trading methods do not in general reveal the same information). Third, our model provides a new rationale for why some currency pairs never trade directly (information is not sufficiently symmetric to support trading). Fourth, our model formalizes the arbitrage process and shows that arbitrage transaction quantities and price levels are jointly determined. Empirically, the paper provides a first integrated analysis of transactions in a triangle of markets: ¥/$, $/Euro, and ¥/Euro. Data for the full triangle permits comparison of direct, indirect and arbitrage transactions, for each pair. The information model predicts that transactions should affect prices across markets (e.g., flow in the ¥/$ market should convey information relevant to $/Euro and ¥/Euro prices), which is borne out.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11220.

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Date of creation: Mar 2005
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Publication status: published as Lyons, Richard K. & Moore, Michael J., 2009. "An information approach to international currencies," Journal of International Economics, Elsevier, vol. 79(2), pages 211-221, November.
Handle: RePEc:nbr:nberwo:11220

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Citations

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Cited by:
  1. Q. Farooq Akram, & Dagfinn Rime & Lucio Sarno, 2005. "Arbitrage in the foreign exchange market: Turning on the microscope," Working Paper, Norges Bank 2005/12, Norges Bank.
  2. repec:spo:wpecon:info:hdl:2441/669 is not listed on IDEAS
  3. Potì, Valerio & Siddique, Akhtar, 2013. "What drives currency predictability?," Journal of International Money and Finance, Elsevier, Elsevier, vol. 36(C), pages 86-106.
  4. Flandreau, Marc & Jobst, Clemens, 2006. "The Empirics of International Currencies: Historical Evidence," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5529, C.E.P.R. Discussion Papers.
  5. Takatoshi Ito & Yuko Hashimoto, 2006. "Price Impacts of Deals and Predictability of the Exchange Rate Movements," NBER Working Papers 12682, National Bureau of Economic Research, Inc.
  6. Dagfinn Rime & Hans Jørgen Tranvåg, 2012. "The Flows of the Pacific: Asian foreign exchange markets through tranquility and turbulence," Working Paper, Norges Bank 2012/01, Norges Bank.
  7. Akram, Q. Farooq & Rime, Dagfinn & Sarno, Lucio, 2009. "Does the law of one price hold in international financial markets? Evidence from tick data," Journal of Banking & Finance, Elsevier, Elsevier, vol. 33(10), pages 1741-1754, October.
  8. Moore, Michael J. & Payne, Richard, 2011. "On the sources of private information in FX markets," Journal of Banking & Finance, Elsevier, Elsevier, vol. 35(5), pages 1250-1262, May.
  9. Zhang, Cathy, 2013. "An Information-Based Theory of International Currency," MPRA Paper 42114, University Library of Munich, Germany.
  10. Jón Dan�elsson & Ryan Love, 2006. "Feedback trading This paper is also available at www.riskresearch.org," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 11(1), pages 35-53.
  11. Clemens Jobst & Marc Flandreau, 2006. "The Empirics of International Currencies: Evidence from the 19th Century," Sciences Po publications, Sciences Po n°5529, Sciences Po.
  12. Gençay, Ramazan & Gradojevic, Nikola, 2013. "Private information and its origins in an electronic foreign exchange market," Economic Modelling, Elsevier, Elsevier, vol. 33(C), pages 86-93.

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