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Private Beliefs and Information Externalities in the Foreign Exchange Market

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  • Richard K. Lyons

Abstract

An information externality exists in the foreign exchange market due to the fact that traders play two partially conflicting roles: (i) each is a speculator and (ii) each is an information clearinghouse in that each intermediates own-customer orders which convey information. Profit maximization induces traders to underweight fundamental information in making their trades, reducing the degree to which prices reveal information at any given time. In the model, agents update diverse beliefs over time, with transactions-mediated tatonnement. The explicit role for transactions provides a framework for interpreting the relationship between the diversity of beliefs, trading volume, and price adjustment.

Suggested Citation

  • Richard K. Lyons, 1991. "Private Beliefs and Information Externalities in the Foreign Exchange Market," NBER Working Papers 3889, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3889
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    Cited by:

    1. Charles Goodhart & Takatoshi Ito & Richard Payne, 1995. "One Day in June, 1994: A Study of the Working of Reuters 2000-2 Electronic Foreign Exchange Trading System," NBER Technical Working Papers 0179, National Bureau of Economic Research, Inc.
    2. Osler, C. L., 1995. "Exchange rate dynamics and speculator horizons," Journal of International Money and Finance, Elsevier, vol. 14(5), pages 695-719, October.
    3. Carlos A. Ulibarri & Peter C. Anselmo & Karen Hovespian & Jacob Tolk & Ionut Florescu, 2009. "'Noise-trader risk' and Bayesian market making in FX derivatives: rolling loaded dice?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 14(3), pages 268-279.
    4. Poskitt, Russell, 2005. "Bid/ask spreads in the foreign exchange market: An alternative interpretation," Pacific-Basin Finance Journal, Elsevier, vol. 13(5), pages 562-583, November.
    5. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.
    6. Bauwens, Luc & Ben Omrane, Walid & Giot, Pierre, 2005. "News announcements, market activity and volatility in the euro/dollar foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1108-1125, November.
    7. Dick van Dijk & Haris Munandar & Christian M. Hafner, 2005. "The Euro Introduction and Non-Euro Currencies," Tinbergen Institute Discussion Papers 05-044/4, Tinbergen Institute, revised 08 Jun 2006.
    8. Benassy-Quere, Agnes & Larribeau, Sophie & MacDonald, Ronald, 2003. "Models of exchange rate expectations: how much heterogeneity?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 13(2), pages 113-136, April.
    9. Ronald MacDonald, 2000. "Expectations Formation and Risk in Three Financial Markets: Surveying What the Surveys Say," Journal of Economic Surveys, Wiley Blackwell, vol. 14(1), pages 69-100, February.
    10. Hernando Vargas & Yanneth Rocío Betancourt, 2007. "Pension Fund Managers and the Structure of the Foreign Exchange Market," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República, vol. 25(54), pages 122-155, June.
    11. Macdonald, Ronald & Marsh, Ian W., 1996. "Currency forecasters are heterogeneous: confirmation and consequences," Journal of International Money and Finance, Elsevier, vol. 15(5), pages 665-685, October.
    12. Chionis, Dionysios & MacDonald, Ronald, 1997. "Some tests of market microstructure hypotheses in the foreign exchange market," Journal of Multinational Financial Management, Elsevier, vol. 7(3), pages 203-229, October.
    13. Hernando Vargas H. & Rocío Betancourt, 2006. "Pension Fund Managers Behavior In The Foreign Exchange Market," Borradores de Economia 3317, Banco de la Republica.
    14. Bronka Rzepkowski, 2001. "Heterogeneous Expectations, Currency Options and the Euro / Dollar Exchange Rate," Working Papers 2001-03, CEPII research center.

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