We address whether transaction flows in foreign exchange markets convey fundamental information. Our GE model includes fundamental information that first manifests at the micro level and is not symmetrically observed by all agents. This produces foreign exchange transactions that play a central role in information aggregation, providing testable links between transaction flows, exchange rates, and future fundamentals. We test these links using data on all end-user currency trades received at Citibank over 6.5 years, a sample sufficiently long to analyze real-time forecasts at the quarterly horizon. The predictions are borne out in four empirical findings that define this paper's main contribution: (1) transaction flows forecast future macro variables such as output growth, money growth, and inflation, (2) transaction flows forecast these macro variables significantly better than the exchange rate does, (3) transaction flows (proprietary) forecast future exchange rates, and (4) the forecasted part of fundamentals is better at explaining exchange rates than standard measured fundamentals.
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Length: Date of creation: Jun 2007 Date of revision: Handle: RePEc:nbr:nberwo:13151
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Find related papers by JEL classification: F31 - International Economics - - International Finance - - - Foreign Exchange G12 - Financial Economics - - General Financial Markets - - - Asset Pricing G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
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Martin D. D. Evans & Richard K. Lyons, 2005.
"Understanding Order Flow,"
NBER Working Papers
11748, National Bureau of Economic Research, Inc.
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Martin D. D. Evans (Georgetown University), .
"Understanding Order Flow,"
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gueconwpa~05-05-19, Georgetown University, Department of Economics.
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