Foreign Exchange Market Microstructure

Martin Evans

Working Papers from Georgetown University, Department of Economics

Abstract: This paper provides an overview of the recent literature on Foreign Exchange Market Microstructure. Its aim is not to survey the literature, but rather to provide an introductory tour to the main theoretical ideas and empirical results. The central theoretical idea is that trading is an integral part of the process through which information relevant to the pricing of foreign currency becomes embedded in spot rates. Micro-based models study this information aggregation process and produce a rich set of empirical predictions that find strong support in the data. In particular, micro-based models can account for a large proportion of the daily variation in spot rates. They also supply a rationale for the apparent disconnect between spot rates and fundamentals. In terms of forecasting, micro-based models provide out-of-sample forecasting power for spot rates that is an order of magnitude above that usually found in exchange-rate models.

Keywords: Exchange Rates; Microstructure; Information Aggregation; FX Trading. (search for similar items in EconPapers)
JEL-codes: F3 F4 G1 (search for similar items in EconPapers)
Date: 2005-05-20
New Economics Papers: this item is included in nep-fin, nep-fmk, nep-for and nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:geo:guwopa:gueconwpa~05-05-20

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