Uninformed but Predictable: Corporate Trading and Price Discovery in Over-the-counter FX Markets

71 Pages Posted: 29 Apr 2022 Last revised: 13 Jun 2022

See all articles by Umang Khetan

Umang Khetan

University of Iowa - Department of Finance

Petra Sinagl

University of Iowa - Department of Finance

Date Written: June 2022

Abstract

We characterize the demand function of multi-national corporations in foreign exchange (FX) markets and assess its impact on asset prices. Our findings suggest that corporate order flow does not consistently predict future returns, it is highly auto-correlated and, in contrast to pure noise, it strongly responds to realized asset returns. Further, we find compelling evidence of a positive impact of corporations’ net order imbalance on the post-execution volatility of currency returns. Using settlement breaks to instrument for quasi-exogenous shocks to liquidity-motivated trading, we show that a one standard-deviation drop in traded volume decreases return volatility by 38%. This effect dissipates within a trading day. We document that order imbalance also impacts dealers’ price spreads to corporations, but observable currency and trade characteristics explain less than 1% of the variation. Based on these empirical facts, we propose a dynamic model of price determination between a dealer and an uninformed agent in a setting with asymmetric information, multi-period relationships and search frictions.

Keywords: Foreign Exchange, Market Microstructure, Information, Volatility

JEL Classification: F31, G12, G15

Suggested Citation

Khetan, Umang and Sinagl, Petra, Uninformed but Predictable: Corporate Trading and Price Discovery in Over-the-counter FX Markets (June 2022). Available at SSRN: https://ssrn.com/abstract=4090782 or http://dx.doi.org/10.2139/ssrn.4090782

Umang Khetan (Contact Author)

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States

Petra Sinagl

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States

HOME PAGE: http://andrlikova.com

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