'Once-in-A-Generation' Yen Volatility in 1998: Fundamentals, Intervention, and Order Flow

Arizona State University Working Paper No. 99/7

34 Pages Posted: 24 Feb 2000

See all articles by Jun Cai

Jun Cai

City University of Hong Kong (CityUHK) - Department of Economics & Finance

Stephen Yan-Leung Cheung

City University of Hong Kong (CityUHK) - Department of Economics & Finance

Raymond S. Lee

City University of Hong Kong (CityUHK)

Michael Melvin

University of California, San Diego (UCSD) - Rady School of Management; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: November 1999

Abstract

The yen provided foreign exchange market participants with 'once-in-a-generation' volatility movements in 1998. For instance, after many months of uneven yen depreciation a remarkable period of yen appreciation was experienced where, in one two-day period, the U.S. dollar dropped in value by 20 yen, market-makers were refusing to quote yen/dollar prices for more than $1 million, and funds with short yen positions incurred massive losses. Not since the early 1970s has the yen-dollar exchange rate experienced such shifts. Analysts claimed that the yen reversal was due to order flow driven by changing tastes for risk and hedge-fund herding on unwinding yen 'carry trade' positions rather than any fundamentals related to the yen. In this paper, we examine the high-frequency evidence on the yen/dollar exchange rate in 1998 and provide a detailed characterization of the return volatility. Evidence of shifting fundamentals is provided by a comprehensive list of macroeconomic announcements from both the U.S. and Japan. While macroeconomic announcements and intervention are found to have significant effects on volatility, our results lead to the conclusion that order flow played a more important role than news regarding fundamentals. Evidence regarding the independent effect of order flow was provided by spot, forward, and futures positions of major market participants. These position changes are found to be significant determinants of volatility. Since such portfolio shifts are revealed to the market through trading, the results are consistent with order flow playing a significant role in the revelation of private information and the associated exchange rate shifts.

JEL Classification: F31

Suggested Citation

Cai, Jun and Cheung, Stephen Yan-Leung and Lee, Raymond S. and Melvin, Michael, 'Once-in-A-Generation' Yen Volatility in 1998: Fundamentals, Intervention, and Order Flow (November 1999). Arizona State University Working Paper No. 99/7, Available at SSRN: https://ssrn.com/abstract=201029 or http://dx.doi.org/10.2139/ssrn.201029

Jun Cai

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Stephen Yan-Leung Cheung

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
+852 2788 7960 (Phone)
+852 2788 8806 (Fax)

Raymond S. Lee

City University of Hong Kong (CityUHK)

83 Tat Chee Avenue
Kowloon
HONG KONG

Michael Melvin (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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