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Inventory Information

In: Studies in Foreign Exchange Economics

Author

Listed:
  • H. Henry Cao
  • Martin D. D. Evans
  • Richard K. Lyons

Abstract

When information about fundamentals is symmetric, can information-based trade still arise? The question is central to our understanding of some important markets, e.g., government bond and FX markets, where the premise of symmetric information about fundamentals is natural, yet participants are convinced that superior information exists (see, e.g., Cheung and Wong, 2000; Ciccotello and Hatheway, 2000; Massa and Simonov, 2003; Green, 2004). To resolve the puzzle, we address a class of information that we call inventory information. Inventory information is orthogonal to fundamentals (that is, orthogonal to cash flows from holding the asset, e.g., future coupons and principal in the case of a bond, and future interest differentials in the case of FX). At the same time, inventory information has the power to forecast future price. It does so by forecasting future discount factors (over both short and long horizons). Inventory information is also asymmetric: initially it manifests in marketmaker positions, which are privately observed, and is only subsequently impounded in price. These two features – ability to forecast price and private observation – provide the basis for information-based trade…

Suggested Citation

  • H. Henry Cao & Martin D. D. Evans & Richard K. Lyons, 2017. "Inventory Information," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 9, pages 363-413, World Scientific Publishing Co. Pte. Ltd..
  • Handle: RePEc:wsi:wschap:9789813148543_0009
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    Keywords

    Exchange Rates; Foreign Currency; Microstructure;
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    • F31 - International Economics - - International Finance - - - Foreign Exchange

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