New Economics Papers
on Market Microstructure
Issue of 2006‒11‒04
three papers chosen by
Thanos Verousis

  1. Price Discovery in Currency Markets By Osler, Carol; Mende, Alexander; Menkhoff, Lukas
  2. Persistence, Performance and Prices in Foreign Exchange Markets By Ramadorai, Tarun
  3. The Obstinate Passion of Foreign Exchange Professionals : Technical Analysis By Menkhoff, Lukas; Taylor, Mark P.

  1. By: Osler, Carol; Mende, Alexander; Menkhoff, Lukas
    Abstract: This paper makes three contributions to our understanding of the price discovery process in currency markets. First, it provides evidence that this process cannot be the familiar one based on adverse selection and customer spreads, since such spreads are inversely related to a trade's likely information content. Second, the paper suggests three potential sources for the pattern of customer spreads, two of which rely on the information structure of the market. Third, the paper suggests an alternative price discovery process for currencies, centered on inventory management strategies in the interdealer market, and provides preliminary evidence for that process.
    Keywords: Bid-ask spread, foreign exchange, asymmetric information, microstructure, price discovery, interdealer, inventory, market order, limit order
    JEL: F31 G14 G15
    Date: 2006–11
  2. By: Ramadorai, Tarun
    Abstract: Using detailed data on currency transactions of institutional investors, this paper shows that funds that experience high returns on their currency holdings also execute currency trades at more favourable prices. This observation is consistent with foreign exchange dealers bidding for information from successful traders. If true, this provides little incentive for successful funds to intertemporally split orders to avoid tipping off dealers. In accordance with this, the paper finds that better performing funds have less persistent currency order flow. These results are consistent with the theoretical model of Naik, Neuberger and Viswanathan [1999]. The results can also be explained by the funds acting as secondary providers of liquidity in these markets, or by dealers perceiving that funds have different price elasticities of demand for currencies, and pricing accordingly.
    Keywords: foreign exchange; microstructure; order flow; performance
    JEL: G10 G15
    Date: 2006–10
  3. By: Menkhoff, Lukas (University of Hannover); Taylor, Mark P. (University of Warwick and Centre for Economic Policy Research)
    Abstract: Technical analysis involves the prediction of future exchange rate (or other assetprice) movements from an inductive analysis of past movements. A reading of the large literature on this topic allows us to establish a set of stylised facts, including the facts that technical analysis is an important and widely used method of analysis in the foreign exchange market and that applying certain technical trading rules over a sustained period may lead to significant positive excess returns. We then analyze four arguments that have been put forward to explain the continuing widespread use of technical analysis and its apparent profitability: that the foreign exchange market may be characterised by not-fully-rational behaviour; that technical analysis may exploit the influence of central bank interventions; that technical analysis may be an efficient form of information processing ; and finally that it may provide information on nonfundamental influences on foreign exchange movements. Although all of these positions may be relevant to some degree, neither non-rationality nor official interventions seem to be widespread and persistent enough to explain the obstinate passion of foreign exchange professionals for technical analysis.
    Keywords: foreign exchange market ; technical analysis ; market microstructure
    JEL: F31
    Date: 2006

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