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Working papers by Rich Lyons in New Micro
exchange-rate economics
Forecasting Exchange Rate Fundamentals with Order Flow
Martin D.D. Evans and Richard K. Lyons
July 2009
Abstract
This paper addresses whether transaction flows in foreign exchange markets
convey information about fundamentals. We begin with a GE model in the
spirit of Hayek (1945) in which fundamental information is first manifest
in the economy at the micro level, i.e., in a way that is not symmetrically
observed by all agents. With this information structure, induced foreign
exchange transactions play a central role in the aggregation process,
providing testable links between transaction flows, exchange rates, and
future fundamentals. We test these links using data on end-user trades at a
major bank over six years, a sample sufficiently long to analyze real-time
forecasts at the quarterly horizon. Four findings are both new to the
literature and supportive of our model: (1) transaction flows forecast
future macro variables such as output growth, money growth, and inflation,
(2) transaction flows generally forecast these macro variables better than
spot rates do, (3) transaction flows (proprietary) forecast future spot
rates, and (4) though flows convey new information about future
fundamentals, much of this information is still not impounded in the spot
rate one quarter later. The significance of transaction flows for exchange
rates appears to extend well beyond high frequencies.
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for a copy of the paper in Adobe's PDF format.
An Information Approach to International Currencies
Richard K. Lyons and Michael J. Moore
Forthcoming, Journal of International
Economics
August 2008
Abstract
Models of currency
competition focus on the 5 percent of trading attributable to
balance-of-payments flows. We introduce an information approach that
focuses on the other 95 percent. Important departures from traditional
models arise when transactions convey information. First, prices reveal
different information depending on whether trades are direct or though
vehicle currencies. Second, missing markets arise due to insufficiently
symmetric information, rather than insufficient transactions scale. Third, the
indeterminacy of equilibrium that arises in traditional models is resolved:
currency trade patterns no longer concentrate arbitrarily on market size.
Empirically, we provide a first analysis of transactions across a full
market triangle: the euro, yen and US dollar. The estimated transaction
effects on prices support the information approach.
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for a copy of the paper in Adobe's PDF format.
Does Intervention Alter Private Behavior?
Eric Girardin and Richard K. Lyons
June 2008
Abstract
A new line of theory posits
that intervention in currency markets works indirectly, either by (1)
coordinating private trades in the same direction or (2) damping the price
impact of private trades. Using daily data on trades from three
institution types—hedge funds, mutual funds, and non-financial corporations—we
find strong evidence for the coordination channel. Over the period of aggressive Japanese intervention in 2003-04, the
trades of corporations and hedge funds shifted
significantly in the intervention direction. Evidence for the second, the
damping channel, is present in periods when exchange rate stabilization was
successful.
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paper in Adobe's PDF format.
A New Micro Model of Exchange Rate Dynamics
Martin D.D. Evans and Richard K. Lyons
August 2005 (also NBER Working Paper 10379)
Abstract
We address the puzzle of exchange rate determination by examining how
information is aggregated in dynamic general equilibrium (DGE). Unlike
other DGE macro models, which enrich either preference structures or
production structures, our model enriches the information structure. The
model departs from microstructure-style modeling by identifying the real
activities where dispersed information originates, as well as the
technology by which information is subsequently aggregated and impounded.
Results relevant to the determination puzzle include: (1) persistent gaps
between exchange rates and macro fundamentals, (2) excess volatility
relative to macro fundamentals, (3) exchange rate movements without macro
news, (4) little or no exchange rate movement when macro news occurs, and
(5) a structural-economic resolution of the "order flow
puzzle"--that transaction flows can account for monthly exchange rate
changes, whereas macro variables cannot. Though micro analysis has already
made progress on results (1) and (2), our results on these points arise for
a qualitatively different reason: here, rational exchange rate errors feed
back into, and persistently alter, the underlying real fundamentals.
Calibrations show that the effects of micro-based information aggregation
significantly weaken the empirical link between exchange rates and
fundamentals over macro-relevant horizons.
Click here for a copy
of the paper in Adobe's PDF format.
Contact Information
Rich Lyons
Former Dean, Haas School of Business
UC Berkeley
Berkeley, CA 94720-1900
Tel: 510-643-2027
Fax: 510-642-5630
lyons@haas.berkeley.edu
Assistant to the Former Dean:
Marco Lindsey
Tel: 510-643-2027
Fax: 510-642-5630
marco@haas.berkeley.edu
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