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The role of asymmetric information among investors in the foreign exchange market

  • Esen Onur

    (Department of Economics, California State University, Sacramento 6000J Street, Sacramento, CA 95819-6082, USA)

This paper posits asymmetric information as the missing link between the currency demands of investors and changes in the exchange rate. A theoretical model demonstrates that changes in the exchange rate and currency demand are positively correlated for well-informed investors and negatively correlated for less well-informed investors, results consistent with stylized facts from the empirical literature. These theoretical findings are supported empirically using a new data set from the Israeli foreign exchange market. The empirical analysis indicates that a one million dollar larger purchase than sales by well-informed financial investors induces an increase of 0.060 per cent in the Israeli Sheqel|Dollar exchange rate over a one month period. A similar net flow from less well-informed investors results in a 0.046 per cent decrease in the exchange rate. Copyright © 2008 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.367
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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 13 (2008)
Issue (Month): 4 ()
Pages: 368-385

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Handle: RePEc:ijf:ijfiec:v:13:y:2008:i:4:p:368-385
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  1. Philippe Bacchetta & Eric van Wincoop, 2003. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," Working Papers 03.02, Swiss National Bank, Study Center Gerzensee.
  2. Flood, Robert P & Rose, Andrew K, 1993. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," CEPR Discussion Papers 838, C.E.P.R. Discussion Papers.
  3. Wu, Thomas Y, 2008. "Order Flow in the South: Anatomy of the Brazilian FX Market," Santa Cruz Department of Economics, Working Paper Series qt968459j2, Department of Economics, UC Santa Cruz.
  4. Geir Høidal Bjønnes & Dagfinn Rime & Haakon O. Aa. Solheim, 2004. "Liquidity provision in the overnight foreign exchange market," Working Paper 2004/13, Norges Bank.
  5. Martin D. D. Evans & Richard K. Lyons, 2002. "Order Flow and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 110(1), pages 170-180, February.
  6. Martin D. D. Evans (Georgetown University), 2005. "Understanding Order Flow," Working Papers gueconwpa~05-05-19, Georgetown University, Department of Economics.
  7. Carol L. Osler, 2006. "Macro lessons from microstructure," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(1), pages 55-80.
  8. Wang, Jiang, 1993. "A Model of Intertemporal Asset Prices under Asymmetric Information," Review of Economic Studies, Wiley Blackwell, vol. 60(2), pages 249-82, April.
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