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

Jun Cai, Yan-Leung Cheung, Raymond Lee and Michael Melvin ()
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Jun Cai: City University of Hong Kong, http://wpcarey.asu.edu/Directory/stafffaculty.cfm?cobid=2133560
Yan-Leung Cheung: City University of Hong Kong, http://wpcarey.asu.edu/Directory/stafffaculty.cfm?cobid=2133562
Raymond Lee: City University of Hong Kong, http://wpcarey.asu.edu/Directory/stafffaculty.cfm?cobid=2133563
Michael Melvin: W. P. Carey School of Business Department of Economics, http://wpcarey.asu.edu/Directory/stafffaculty.cfm?cobid=1039591

Working Papers from Department of Economics, W. P. Carey School of Business, Arizona State University

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-codes: C22 F31 G14 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-ifn and nep-sea
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