Extreme Returns without News: The Case of Currencies

50 Pages Posted: 20 Feb 2009

See all articles by Tanseli Savaser

Tanseli Savaser

Vassar College - Department of Economics

Carol L. Osler

Brandeis University - International Business School

Date Written: February 16, 2009

Abstract

What triggers extreme returns in financial markets? In standard theoretical models news is the only trigger, but in foreign exchange and equity markets extreme returns often occur in the absence of news. This paper investigates how the distribution of currency returns, and in particular the frequency of extreme returns, is influenced by price-contingent trading, a category that includes most technical trading, algorithmic trading, and dynamic option hedging. In so doing it suggests that extreme exchange-rate returns and (more generally) high return kurtosis are statistically inevitable even in the absence of news. Using data on price-contingent currency orders we identify four microstructural sources of return kurtosis: (1) high kurtosis in the size distribution of price-contingent orders; (2) clustering of price-contingent order executions at certain times of day; (3) clustering of order executions at certain price levels; and (4) the feedback from returns to trades. When each factor operates in isolation, kurtosis in the order-size distribution contributes the most to return kurtosis. When the factors operate simultaneously, however, their interactions prove far more important than any single one. Together, these features of price-contingent trading can account for a substantial fraction of observed kurtosis in exchange-rate returns.

Keywords: kurtosis, exchange rates, order flow, high-frequency, microstructure

JEL Classification: G1, F3

Suggested Citation

Savaser, Tanseli and Osler, Carol L., Extreme Returns without News: The Case of Currencies (February 16, 2009). Available at SSRN: https://ssrn.com/abstract=1344854 or http://dx.doi.org/10.2139/ssrn.1344854

Tanseli Savaser

Vassar College - Department of Economics ( email )

124 Raymond Avenue
Poughkeepsie, NY 12604
United States

Carol L. Osler (Contact Author)

Brandeis University - International Business School ( email )

Mailstop 32
Waltham, MA 02454-9110
United States
781-736-4826 (Phone)

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