Marketwide Private Information in Stocks: Forecasting Currency Returns
Rui A. Albuquerque
Boston University - School of Management; Católica-Lisbon School of Business and Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
Eva De Francisco
Congressional Budget Office (CBO) - Macroeconomic Analysis Division
Luis Brandao Marques
International Monetary Fund (IMF) - IMF Institute
February 17, 2007
AFA 2007 Chicago Meetings Paper
We present a model of equity trading with informed and uninformed investors where informed investors act upon firm-specific private information and marketwide private information. The model is used to structurally identify the component of order flow that is due to marketwide private information. Estimated trades driven by marketwide private information display very little or no correlation with the first principal component in order flow. This finding implies that a simple statistical factor of order flow is a poor measure of marketwide private information. Moreover, the model suggests that the previously documented co-movement in order flow captures mostly variation in liquidity trades. Marketwide private information obtained from equity market data forecasts industry stock returns. It also forecasts foreign exchange returns consistent with Evans and Lyons' (2004a) model of exchange rate determination.
Number of Pages in PDF File: 57
Keywords: Marketwide private information, firm-specific private information, order flow, principal components, currency returns, equity returns
JEL Classification: F31, G11, G14working papers series
Date posted: March 1, 2006
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