Hedge Funds and the Origins of Private Information in Currency Markets
30 Pages Posted: 10 Oct 2009
Date Written: April 2009
This paper provides evidence that hedge funds are a critical source of private fundamental information in currency markets. We analyze the most disaggregated database of currency transactions to date, with ten different categories of market participants including six categories of end users. Our analysis of the information content of individual trades indicates that only one category of end user has information, specifically hedge funds. Orders placed by institutional investors, broker-dealers, central banks and government agencies, large corporations, and middle-market corporations provide little information about upcoming returns. Orders of banks in every size category carry information, consistent with now-standard theory that banks gather information from observing customer trades. Theory does not indicate whether banks should be better informed than their customers. Our results suggest that banks are better informed than their individual customers, possibly because they aggregate information from many customers.
Keywords: microstructure, exchange rates, asymmetric information
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