FX Trading and Exchange Rate Dynamics

  • Author(s): Martin D. D. Evans
  • Published: Dec 17, 2002
  • Pages: 2405-2447
  • DOI: 10.1111/1540-6261.00501

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 anyhorizon.

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