When Do Informed Traders Arrive in Foreign Exchange Markets?

28 Pages Posted: 14 Dec 2007

See all articles by Ramazan Gencay

Ramazan Gencay

Simon Fraser University

Nikola Gradojevic

University of Guelph, Department of Economics and Finance; University of Bologna - Rimini Center for Economic Analysis (RCEA)

Faruk Selcuk

Bilkent University - Department of Economics

Date Written: November 2007

Abstract

This article examines the implications of the existence of private information in the spot foreign exchange market. Our framework is a high-frequency version of a structural microstructure trade model that measures the market maker's beliefs directly. We find that the underpinnings for the time-varying pattern of the probability of informed trading are rooted in the strategic arrival of informed traders on a particular hour-of-day, day-of-week, and geographic location (market). Specifically, we document that informed traders not only pick the low activity hours, but also attach the largest market weight to a particular market. The distributions of the estimated arrival rates confirm the commitment of the informed traders to strategic trading activities. In our framework, we acknowledge that an expected loss of informed trading to the market maker is a function of both the probability of informed trading and its likely impact on the price. The impact of the uninformed traders arrival on the daily foreign exchange price volatility is about twice the magnitude of the one for informed traders. These effects are in stark contrast to the findings from the hourly data that indicate dominance of informed traders. Finally, the results relate the informational content of trading to the trade size and suggest that the probability of the informed large trading is significantly higher than the probability of uninformed large trading.

Keywords: Foreign Exchange Markets, Volume, Informed Trading, Noise Trading

JEL Classification: G0, G1

Suggested Citation

Gencay, Ramazan and Gradojevic, Nikola and Selcuk, Faruk, When Do Informed Traders Arrive in Foreign Exchange Markets? (November 2007). Available at SSRN: https://ssrn.com/abstract=1071343 or http://dx.doi.org/10.2139/ssrn.1071343

Ramazan Gencay (Contact Author)

Simon Fraser University ( email )

Department of Economics
8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Nikola Gradojevic

University of Guelph, Department of Economics and Finance ( email )

50 Stone Road East
Guelph, Ontario N1G 2W1
Canada

HOME PAGE: http://https://www.uoguelph.ca/economics/users/nikola-gradojevic

University of Bologna - Rimini Center for Economic Analysis (RCEA) ( email )

Via Patara, 3
Rimini (RN), RN 47900
Italy

Faruk Selcuk

Bilkent University - Department of Economics ( email )

06800 Ankara
Turkey
+90 (312) 290 2074 (Phone)
+90 (312) 266-5140 (Fax)

HOME PAGE: www.bilkent.edu.tr/~faruk

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