When do informed traders arrive in foreign exchange markets?
Gencay, Gradojevic, Selcuk April 2008
http://economics.ca/2008/papers/0027.pdf-----------------------------------------------
Abstract
This article examines the implications of the existence of private information in the spot foreign
exchange market. Our framework is a high-frequency version of a structural microstructure
trade model that measures the market maker’s beliefs directly. We find that the underpinnings
for the time-varying pattern of the probability of informed trading are rooted in the strategic
arrival of informed traders on a particular hour-of-day, day-of-week, and geographic location
(market). Specifically, we document that informed traders not only pick the low activity hours,
but also attach the largest market weight to a particular market. The distributions of the
estimated arrival rates confirm the commitment of the informed traders to strategic trading
activities. In our framework, we acknowledge that an expected loss of informed trading to the
market maker is a function of both the probability of informed trading and its likely impact on
the price. The impact of the uninformed traders’ arrival on the daily foreign exchange price
volatility is about twice the magnitude of the one for informed traders. These effects are in
stark contrast to the findings from the hourly data that indicate dominance of informed traders.
Finally, the results relate the informational content of trading to the trade size and suggest
that the probability of the informed large trading is significantly higher than the probability of
uninformed large trading.
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