Foreign Exchange Volume: Sound and Fury Signifying Nothing?

Abstract

Volume in the spot foreign exchange market dwarfs that in any other financial market. But is all this trading informative? This paper provides some empirical evidence. At the broadest level, my results help clarify why trading volume in this market is extraordinarily high. At a narrower level, I provide some sharp results regarding the relation between the intensity of trading and the informa-tiveness of trades. Specifically, I provide results that discriminate between polar views of trad-ing intensity, to which I refer as (1) the event-uncertainty view and (2) the hot potato view. The event-uncertainty view holds that trades are more informative when trading intensity is high; the hot potato view holds that trades are more informative when trading intensity is low. In general, theory admits both possi-bilities, depending primarily on the posited information structure. To understand the event-uncertainty view—that trades are more informative when trading intensity is high—consider the work of Easley and O'Hara (1992). In contrast to earlier models where new information is known to exist,