Asymmetric Information and Price Discovery in the FX Market: Does Tokyo Know More About the Yen?

Abstract

We identify a period in the foreign exchange market when there is a high concentration of informed yen/dollar traders active in Tokyo. We exploit the data during this period to test implications of market-microstructure theory. Comparing the period of informed trader clustering to a similar period without the informed, we find the following results: 1. Exchange rate quotes adjust to full-information levels six times faster when the informed are active than when they are not. 2. Japanese quotes tend to lead the rest of the market when the informed are active. At other times, two-way causality is observed in quotes. 3. The contribution of Japanese quotes to yen/dollar price discovery relative to quotes of the rest-of-the-world is 5 to 12 percentage points higher when the informed are active compared to when they are absent. These results are consistent with a view of the foreign exchange market where private information is at times quite important, yet normal times are characterized as periods where public information, shared equally by all, results in a high contemporaneous correlation across quotes, regardless of origin.