The Impact of Central Bank Communication Choices in a Market with Fast and Slow Traders

Abstract

We study the impact of different central bank communication practices on market liquidity, volatility and the trading behavior and profitability of fast and slow traders in the foreign exchange market. We find that the Bank of Japan's practice of introducing some randomness to the exact time of day at which it releases its monetary policy statement increases illiquidity and realized volatility well before the release time. This contrasts with what we observe for the Federal Reserve and the European Central Bank, which both release their monetary policy statements at fixed pre-announced times. We show that the additional uncertainty due to the random timing of the Bank of Japan's announcement gives an advantage to fast traders, especially when they trade aggressively against slower traders in the market. We relate our findings to the theory of market liquidity provision under adverse selection risk and to the discussion of how information asymmetry affects fast and slow traders in financial markets in which they coexist.

Keywords: Monetary policy, public information, high frequency traders, random release times, central bank and CEO communication

JEL Classification: C53, D83, E27, E37, E44, E47, E5, G1