... In related papers, such as Kyle, 1985 and Bhattacharya and Weller, 1993, noise trader shocks ... more ... In related papers, such as Kyle, 1985 and Bhattacharya and Weller, 1993, noise trader shocks are not common knowledge since they cannot be distinguished from other market information, and the asymmetric availability of these two information sources is crucial to the results. ...
Journal of Financial and Quantitative Analysis, Jan 6, 2012
Bank, and the Federal Reserve Bank of New York. Also, we acknowledge with thanks each foreign exc... more Bank, and the Federal Reserve Bank of New York. Also, we acknowledge with thanks each foreign exchange professional who took the time to fill out the survey. We gratefully acknowledge financial support for this research from Hottinger & Partner and the Austrian Science Fund (Schroedinger Scholarship #J2219 and #J1955-SOZ). Survival of Overconfidence in Currency Markets This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrational traders will be driven out of financial markets by trading losses. The paper's main finding is that overconfident currency dealers are not driven out of the market. Dealers with extensive experience are neither more nor less overconfident than their junior colleagues. We set the stage for this investigation by providing evidence that currency dealers display two forms of overconfidence: they underestimate uncertainty and they overestimate their professional success. This is notable since dealers face strong incentives to accuracy, have access to comprehensive information, and have extensive experience.
What triggers extreme exchange-rate returns? Though news is the source of volatility in standard ... more What triggers extreme exchange-rate returns? Though news is the source of volatility in standard theoretical models, in reality volatility is often unrelated to news. This paper shows that extreme exchange-rate returns-and, more generally, high kurtosis of returns-are statistically inevitable even in the absence of news. We identify four microstructural sources of return kurtosis in price-contingent order flow: (1) high kurtosis in the distribution of price-contingent order sizes; (2) clustering of price-contingent order executions at certain times of day; (3) clustering of order executions at certain price levels; and (4) the tendency of positive-feedback trading to propagate trends. Using simulations calibrated to price-contingent orders placed at a major foreign exchange dealing bank we show that when each factor operates in isolation, the one that contributes most to kurtosis in returns is kurtosis in the order-size distribution. When the factors operate simultaneously, however, their interactions prove far more important. Extreme returns in the absence of news should be viewed as natural rather than anomalous.
Federal Reserve Bank of New York Economic policy review, 1994
During the second quarter of 2001, the dollar appreciated 3.3 percent against the euro and deprec... more During the second quarter of 2001, the dollar appreciated 3.3 percent against the euro and depreciated 1.2 percent against the yen. On a trade-weighted basis, the dollar ended the quarter nearly unchanged against the currencies of the United States' major trading partners. Over the quarter, market perceptions that the U.S. economy would emerge from its downturn sooner than the euro area provided underlying support for the dollar. The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter.
Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.
Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.
This paper suggests a plausible microstructural connection between rational speculative activity ... more This paper suggests a plausible microstructural connection between rational speculative activity and exchange rate volatility. When Friedman (1953) claimed that rational speculators must smooth exchange rates, he excluded interest rate differentials from his interpretation of speculator behavior. Informed, rational speculators who consider interest differentials will magnify the exchange rate effects of interest shocks and could increase overall exchange rate volatility. This connection between speculators and volatility, which does not rely on asymmetric information, is structural because speculators affect the exchange rate's generating process. Rational speculation is stabilizing at low levels of speculative activity and destabilizing at high levels. (J.E.L. codes F31, G12.
This paper investigates how active price-contingent trading contributes to extreme returns even i... more This paper investigates how active price-contingent trading contributes to extreme returns even in the absence of news. Price-contingent trading, which is common across financial markets, includes algorithmic trading, technical trading, and dynamic option hedging. The paper highlights four properties of such trading that increase the frequency of extreme returns, and then estimates the relative of these properties using data from the foreign exchange market. The four key properties we consider are: (1) high kurtosis in the distribution of order sizes; (2) clustering of trades within the day; (3) clustering of trades at certain prices; and (4) positive and negative feedback between trading and returns. Calibrated simulations indicate that interactions among these properties are at least as important as any single one. Among individual properties, the orders" size distribution and feedback effects have the strongest influence. Price-contingent trading could account for over half of realized excess kurtosis in currency returns.
This paper examines the price discovery process in a two-tier market, specifically the foreign ex... more This paper examines the price discovery process in a two-tier market, specifically the foreign exchange market. The goal is to identify the sources of private information and to gain insights into the process through which that information influences the market price. Using a transactions database that includes trading-party identities, we show that sustained post-trade returns rise with bank size, implying that larger banks have an information advantage. The larger banks exploit this information advantage in placing limit orders as well as market orders. We also show that the bank’s private information does not come from their corporate or government customers or from some asset managers. Instead, the bank’s private information appears to come from other asset managers, including hedge funds, and from the bank’s own analysis.
Research on foreign exchange market microstructure stresses the importance of order flow, heterog... more Research on foreign exchange market microstructure stresses the importance of order flow, heterogeneity among agents, and private information as crucial determinants of short-run exchange rate dynamics. Microstructure researchers have produced empiricallydriven models that fit the data surprisingly well. But FX markets are evolving rapidly in response to new electronic trading technologies. Transparency has risen, trading costs have tumbled, and transaction speed has accelerated as new players have entered the market and existing players have modified their behavior. These changes will have profound effects on exchange rate dynamics. Looking forward, we highlight fundamental yet unanswered questions on the nature of private information, the impact on market liquidity, and the changing process of price discovery. We also outline potential microstructure explanations for longstanding exchange rate puzzles.
Research on foreign exchange market microstructure stresses the importance of order flow, heterog... more Research on foreign exchange market microstructure stresses the importance of order flow, heterogeneity among agents, and private information as crucial determinants of short-run exchange rate dynamics. Microstructure researchers have produced empirically-driven models that fit the data surprisingly well. But FX markets are evolving rapidly in response to new electronic trading technologies. Transparency has risen, trading costs have tumbled, and transaction speed has accelerated as new players have entered the market and existing players have modified their behavior. These changes will have profound effects on exchange rate dynamics. Looking forward, we highlight fundamental yet unanswered questions on the nature of private information, the impact on market liquidity, and the changing process of price discovery. We also outline potential microstructure explanations for long-standing exchange rate puzzles.
International Journal of Finance & Economics, Sep 2, 2020
This paper examines the price discovery process in a two-tier market, specifically the foreign ex... more This paper examines the price discovery process in a two-tier market, specifically the foreign exchange market. The goal is to identify the sources of private information and to gain insights into the process through which that information influences the market price. Using a transactions database that includes trading-party identities, we show that sustained post-trade returns rise with bank size, implying that larger banks have an information advantage. The larger banks exploit this information advantage in placing limit orders as well as market orders. We also show that the bank’s private information does not come from their corporate or government customers or from some asset managers. Instead, the bank’s private information appears to come from other asset managers, including hedge funds, and from the bank’s own analysis.
This paper provides evidence that ''illusory correlations''-a well-documented source of cognitive... more This paper provides evidence that ''illusory correlations''-a well-documented source of cognitive bias-lead some agents to be imperfectly rational noise traders. We focus on the head-andshoulders chart pattern, considered by technical analysts to provide one of the most reliable trading signals. Our findings indicate that the pattern is associated with a substantial rise in trading volume even though it does not profitably predict directional movements. We further substantiate the connection between head-and-shoulders trading and imperfectly rational noise trading by showing that the pattern is associated with lower bid-ask spreads.
This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrati... more This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrational traders will be driven out of financial markets by trading losses. The paper"s main finding is that overconfident currency dealers are not driven out of the market. Traders with extensive experience are neither more nor less overconfident than their inexperienced colleagues. We first provide evidence that currency dealers are indeed overconfident, which is notable since they get daily trading practice and face intense financial incentives to accuracy.
... In related papers, such as Kyle, 1985 and Bhattacharya and Weller, 1993, noise trader shocks ... more ... In related papers, such as Kyle, 1985 and Bhattacharya and Weller, 1993, noise trader shocks are not common knowledge since they cannot be distinguished from other market information, and the asymmetric availability of these two information sources is crucial to the results. ...
Journal of Financial and Quantitative Analysis, Jan 6, 2012
Bank, and the Federal Reserve Bank of New York. Also, we acknowledge with thanks each foreign exc... more Bank, and the Federal Reserve Bank of New York. Also, we acknowledge with thanks each foreign exchange professional who took the time to fill out the survey. We gratefully acknowledge financial support for this research from Hottinger & Partner and the Austrian Science Fund (Schroedinger Scholarship #J2219 and #J1955-SOZ). Survival of Overconfidence in Currency Markets This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrational traders will be driven out of financial markets by trading losses. The paper's main finding is that overconfident currency dealers are not driven out of the market. Dealers with extensive experience are neither more nor less overconfident than their junior colleagues. We set the stage for this investigation by providing evidence that currency dealers display two forms of overconfidence: they underestimate uncertainty and they overestimate their professional success. This is notable since dealers face strong incentives to accuracy, have access to comprehensive information, and have extensive experience.
What triggers extreme exchange-rate returns? Though news is the source of volatility in standard ... more What triggers extreme exchange-rate returns? Though news is the source of volatility in standard theoretical models, in reality volatility is often unrelated to news. This paper shows that extreme exchange-rate returns-and, more generally, high kurtosis of returns-are statistically inevitable even in the absence of news. We identify four microstructural sources of return kurtosis in price-contingent order flow: (1) high kurtosis in the distribution of price-contingent order sizes; (2) clustering of price-contingent order executions at certain times of day; (3) clustering of order executions at certain price levels; and (4) the tendency of positive-feedback trading to propagate trends. Using simulations calibrated to price-contingent orders placed at a major foreign exchange dealing bank we show that when each factor operates in isolation, the one that contributes most to kurtosis in returns is kurtosis in the order-size distribution. When the factors operate simultaneously, however, their interactions prove far more important. Extreme returns in the absence of news should be viewed as natural rather than anomalous.
Federal Reserve Bank of New York Economic policy review, 1994
During the second quarter of 2001, the dollar appreciated 3.3 percent against the euro and deprec... more During the second quarter of 2001, the dollar appreciated 3.3 percent against the euro and depreciated 1.2 percent against the yen. On a trade-weighted basis, the dollar ended the quarter nearly unchanged against the currencies of the United States' major trading partners. Over the quarter, market perceptions that the U.S. economy would emerge from its downturn sooner than the euro area provided underlying support for the dollar. The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter.
Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.
Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch ge... more Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence.
This paper suggests a plausible microstructural connection between rational speculative activity ... more This paper suggests a plausible microstructural connection between rational speculative activity and exchange rate volatility. When Friedman (1953) claimed that rational speculators must smooth exchange rates, he excluded interest rate differentials from his interpretation of speculator behavior. Informed, rational speculators who consider interest differentials will magnify the exchange rate effects of interest shocks and could increase overall exchange rate volatility. This connection between speculators and volatility, which does not rely on asymmetric information, is structural because speculators affect the exchange rate's generating process. Rational speculation is stabilizing at low levels of speculative activity and destabilizing at high levels. (J.E.L. codes F31, G12.
This paper investigates how active price-contingent trading contributes to extreme returns even i... more This paper investigates how active price-contingent trading contributes to extreme returns even in the absence of news. Price-contingent trading, which is common across financial markets, includes algorithmic trading, technical trading, and dynamic option hedging. The paper highlights four properties of such trading that increase the frequency of extreme returns, and then estimates the relative of these properties using data from the foreign exchange market. The four key properties we consider are: (1) high kurtosis in the distribution of order sizes; (2) clustering of trades within the day; (3) clustering of trades at certain prices; and (4) positive and negative feedback between trading and returns. Calibrated simulations indicate that interactions among these properties are at least as important as any single one. Among individual properties, the orders" size distribution and feedback effects have the strongest influence. Price-contingent trading could account for over half of realized excess kurtosis in currency returns.
This paper examines the price discovery process in a two-tier market, specifically the foreign ex... more This paper examines the price discovery process in a two-tier market, specifically the foreign exchange market. The goal is to identify the sources of private information and to gain insights into the process through which that information influences the market price. Using a transactions database that includes trading-party identities, we show that sustained post-trade returns rise with bank size, implying that larger banks have an information advantage. The larger banks exploit this information advantage in placing limit orders as well as market orders. We also show that the bank’s private information does not come from their corporate or government customers or from some asset managers. Instead, the bank’s private information appears to come from other asset managers, including hedge funds, and from the bank’s own analysis.
Research on foreign exchange market microstructure stresses the importance of order flow, heterog... more Research on foreign exchange market microstructure stresses the importance of order flow, heterogeneity among agents, and private information as crucial determinants of short-run exchange rate dynamics. Microstructure researchers have produced empiricallydriven models that fit the data surprisingly well. But FX markets are evolving rapidly in response to new electronic trading technologies. Transparency has risen, trading costs have tumbled, and transaction speed has accelerated as new players have entered the market and existing players have modified their behavior. These changes will have profound effects on exchange rate dynamics. Looking forward, we highlight fundamental yet unanswered questions on the nature of private information, the impact on market liquidity, and the changing process of price discovery. We also outline potential microstructure explanations for longstanding exchange rate puzzles.
Research on foreign exchange market microstructure stresses the importance of order flow, heterog... more Research on foreign exchange market microstructure stresses the importance of order flow, heterogeneity among agents, and private information as crucial determinants of short-run exchange rate dynamics. Microstructure researchers have produced empirically-driven models that fit the data surprisingly well. But FX markets are evolving rapidly in response to new electronic trading technologies. Transparency has risen, trading costs have tumbled, and transaction speed has accelerated as new players have entered the market and existing players have modified their behavior. These changes will have profound effects on exchange rate dynamics. Looking forward, we highlight fundamental yet unanswered questions on the nature of private information, the impact on market liquidity, and the changing process of price discovery. We also outline potential microstructure explanations for long-standing exchange rate puzzles.
International Journal of Finance & Economics, Sep 2, 2020
This paper examines the price discovery process in a two-tier market, specifically the foreign ex... more This paper examines the price discovery process in a two-tier market, specifically the foreign exchange market. The goal is to identify the sources of private information and to gain insights into the process through which that information influences the market price. Using a transactions database that includes trading-party identities, we show that sustained post-trade returns rise with bank size, implying that larger banks have an information advantage. The larger banks exploit this information advantage in placing limit orders as well as market orders. We also show that the bank’s private information does not come from their corporate or government customers or from some asset managers. Instead, the bank’s private information appears to come from other asset managers, including hedge funds, and from the bank’s own analysis.
This paper provides evidence that ''illusory correlations''-a well-documented source of cognitive... more This paper provides evidence that ''illusory correlations''-a well-documented source of cognitive bias-lead some agents to be imperfectly rational noise traders. We focus on the head-andshoulders chart pattern, considered by technical analysts to provide one of the most reliable trading signals. Our findings indicate that the pattern is associated with a substantial rise in trading volume even though it does not profitably predict directional movements. We further substantiate the connection between head-and-shoulders trading and imperfectly rational noise trading by showing that the pattern is associated with lower bid-ask spreads.
This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrati... more This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrational traders will be driven out of financial markets by trading losses. The paper"s main finding is that overconfident currency dealers are not driven out of the market. Traders with extensive experience are neither more nor less overconfident than their inexperienced colleagues. We first provide evidence that currency dealers are indeed overconfident, which is notable since they get daily trading practice and face intense financial incentives to accuracy.
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Papers by Carol Osler