FX Trading and Exchange Rate Dynamics


  • Martin D. D. Evans

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    • Department of Economics at Georgetown University and the N.B.E.R. I am very grateful to Richard Lyons for the many suggestions he made on an earlier draft of this paper. I also thank the seminar participants at Vanderbilt University, the editor, Richard Green, and two anonymous referees for their valuable comments. Part of the research reported on here was conducted while I was visiting the Financial Markets Group at the L.S.E. and The Bank of England. I am grateful for the hospitality I received at both institutions and acknowledge the financial support of the National Science Foundation under Grant 26–3282, and Houblon—Norman Fund at The Bank of England. I also thank the staff at The Bank and Reuters for allowing me to collect the data used in the study. Any errors or omissions are my responsibility.


I examine the sources of exchange rate dynamics by focusing on the information structure of FX trading. This structure permits the existence of an equilibrium distribution of transaction prices at a point in time. I develop and estimate a model of the price distribution using data from the Deutsche mark/dollar market that prroduces two striking results: (1) Much of the short-term volatility in exchange rates comes from sampling the heterogeneous trading decisions of dealers in a distribution that, under normal market conditions, changes comparatively slowly; (2) public news is rarely the predominant source of exchange rate movements over any horizon.