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Private Beliefs and Information Externalities in the Foreign Exchange Market

  • Richard K. Lyons

An information externality exists in the foreign exchange market due to the fact that traders play two partially conflicting roles: (i) each is a speculator and (ii) each is an information clearinghouse in that each intermediates own-customer orders which convey information. Profit maximization induces traders to underweight fundamental information in making their trades, reducing the degree to which prices reveal information at any given time. In the model, agents update diverse beliefs over time, with transactions-mediated tatonnement. The explicit role for transactions provides a framework for interpreting the relationship between the diversity of beliefs, trading volume, and price adjustment.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3889.

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Date of creation: Oct 1991
Date of revision:
Publication status: published as Journal of International Economics, new title," A Simultaneous Trade Model of the Foreign Exchange Hot Potato", February 1997vol. 36.
Handle: RePEc:nbr:nberwo:3889
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  1. Mark D. Flood, 1993. "Market structure and inefficiency in the foreign exchange market," Working Papers 1991-001, Federal Reserve Bank of St. Louis.
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  8. Jeffrey Frankel and Kenneth Froot., 1991. "Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market," Economics Working Papers 91-158, University of California at Berkeley.
  9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  10. Karpoff, Jonathan M, 1986. " A Theory of Trading Volume," Journal of Finance, American Finance Association, vol. 41(5), pages 1069-87, December.
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  13. Rubinstein, Mark, 1975. "Securities Market Efficiency in an Arrow-Debreu Economy," American Economic Review, American Economic Association, vol. 65(5), pages 812-24, December.
  14. Goodhart, Charles, 1988. "The Foreign Exchange Market: A Random Walk with a Dragging Anchor," Economica, London School of Economics and Political Science, vol. 55(220), pages 437-60, November.
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