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The Big Players in the Foreign Exchange Market: Do They Trade on Information or Noise?

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  • Shang-Jin Wei
  • Jungshik Kim

Abstract

This paper studies whether there exists private information in the foreign exchange market, and whether speculation reduces or exacerbates volatility. It makes use of a recent data set on foreign currency positions by large market participants that include positions on options and other derivatives. This is the first data set that describes comprehensive currency positions of market participants. There are two main findings. First, not only the absolute value of the options position but also that of spot, forward and futures positions by large participants Granger-causes exchange rate volatility. This suggests that the large participants' currency speculation does not stabilize exchange rate volatility. Second, regression analyses do not find any positive association between large participants' position in a foreign currency with its subsequent appreciation. A non-parametric approach finds some weak support for a positive association but not on a systematic level. This casts into doubt the view that large participants have better information about the future movement of exchange rates. It further strengthens the case that the large players trade on noise rather than on information.

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Bibliographic Info

Paper provided by Center for International Development at Harvard University in its series CID Working Papers with number 5.

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Date of creation: Mar 1999
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Handle: RePEc:wop:cidhav:5

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Keywords: Exchange rate; asymmetric information; noise trading;

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References

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  1. Sanford J. Grossman, 1989. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," NBER Working Papers 2357, National Bureau of Economic Research, Inc.
  2. Ma, Christopher K & Rao, Ramesh P, 1988. "Information Asymmetry and Options Trading," The Financial Review, Eastern Finance Association, vol. 23(1), pages 39-51, February.
  3. Powers, Mark J, 1970. "Does Futures Trading Reduce Price Fluctuations in the Cash Markets?," American Economic Review, American Economic Association, vol. 60(3), pages 460-64, June.
  4. Mahajan, Arvind & Mehta, Dileep, 1986. "Swaps, expectations, and exchange rates," Journal of Banking & Finance, Elsevier, vol. 10(1), pages 7-20, March.
  5. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
  6. Fieleke, Norman S, 1981. "Foreign-Currency Positioning by U.S. Firms: Some New Evidence," The Review of Economics and Statistics, MIT Press, vol. 63(1), pages 35-42, February.
  7. Robert P. Flood & Andrew K. Rose, 1993. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," NBER Working Papers 4503, National Bureau of Economic Research, Inc.
  8. John B. Corgel & Gerald D. Gay, 1984. "The Impact of GNMA Futures Trading on Cash Market Volatility," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 12(2), pages 176-190.
  9. Lyons, Richard K., 1995. "Tests of microstructural hypotheses in the foreign exchange market," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 321-351.
  10. Anthony, Joseph H, 1988. " The Interrelation of Stock and Options Market Trading-Volume Data," Journal of Finance, American Finance Association, vol. 43(4), pages 949-64, September.
  11. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-37, December.
  12. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-95, June.
  13. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  14. Damodaran, Aswath & Lim, Joseph, 1991. "The effects of option listing on the underlying stocks' return processes," Journal of Banking & Finance, Elsevier, vol. 15(3), pages 647-664, June.
  15. Van Belle, John J, 1975. "The Behavior of Professional Risk-Bearers: Test of a Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 7(2), pages 253-57, May.
  16. Figlewski, Stephen, 1981. "Futures Trading and Volatility in the GNMA Market," Journal of Finance, American Finance Association, vol. 36(2), pages 445-56, May.
  17. Jeffrey A. Frankel., 1987. "Monetary and Portfolio Balance Models of Exchange Rate Determination," Economics Working Papers 8752, University of California at Berkeley.
  18. Skinner, Douglas J., 1989. "Options markets and stock return volatility," Journal of Financial Economics, Elsevier, vol. 23(1), pages 61-78, June.
  19. Conrad, Jennifer, 1989. " The Price Effect of Option Introduction," Journal of Finance, American Finance Association, vol. 44(2), pages 487-98, June.
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