DP16128 Foreign Exchange Volume

Author(s): Giovanni Cespa, Antonio Gargano, Steven Riddiough, Lucio Sarno
Publication Date: May 2021
Keyword(s): Asymmetric information, currency returns, foreign exchange volume
JEL(s): F31, G12, G14, G15
Programme Areas: Financial Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16128

We investigate the information contained in foreign exchange (FX) volume using a novel dataset from the over-the-counter market. We find that volume helps predict next day currency returns and is economically valuable for currency investors. Predictability implies a stronger currency return reversal for currency pairs with abnormally low volume today, and is driven by the component of FX volume unrelated to volatility, illiquidity, and order flow. We rationalize these findings via a simple model of exchange rate determination, in which volume helps reveal the degree of asymmetric information in currency markets. Testing this prediction shows that asymmetric information is uniform across currency pairs but varies across instruments.