Richard K. Lyons

A simultaneous trade model of the foreign exchange hot potato

The foreign exchange market is distinctive at the microstructural level. The three most striking features relative to other markets are: (1) trading volume is enormous, (2) the share of interdealer trading is very high, and (3) the transparency of order flow is very low. This paper introduces a model designed to capture these three features. The model includes multiple dealers who trade with customers and among themselves. In contrast to the sequential move framework of the canonical dealer trading game, here we introduce a simultaneous move trading game (with multiple periods). The model produces hot potato trading among dealers--a term that refers to repeated passing of inventory imbalances. This type of trading appears to account for much of the enormous volume in foreign exchange, and squares with the fact that the share of interdealer trading is very high. We show, however, that hot potato passing of inventories is not innocuous: because the passing of inventories dilutes the information content of order flow, this hampers information aggregation, making price less informative.

Is There Private Information in the FX Market? The Tokyo Experiment

It is a common view that private information in the foreign exchange market does not exist. We provide evidence against this view. The evidence comes from the introduction of trading in Tokyo over the lunch-hour. Lunch return variance doubles with the introduction of trading, which cannot be due to public information since the flow of public information did not change with the trading rules. Having eliminated public information as the cause, we exploit the volatility pattern over the whole day to discriminate between the two alternatives: private information and pricing errors. Three key results support the predictions of private-information models. First, the volatility U-shape flattens: greater revelation over lunch leaves a smaller share for the morning and afternoon. Second, the U-shape tilts upward, an implication of information whose private value is transitory. Finally, the morning exhibits a clear U-shape when Tokyo closes over lunch, and it disappears when trading is introduced.

Internal versus external economies in European industry

Abstract This paper presents estimates of indexes of internal returns to scale and external economies for two-digit manufacturing industries in the four European countries for which the requisite data are available in adequate length: West Germany, France, the U.K., and Belgium. Overall, we find very little evidence of internal increasing returns to scale: of the thirteen two-digit industries, only Rubber and Plastic Products, Agricultural and Industrial Machinery, and Mineral Products exhibit any significant internal increasing returns to scale, and for none of the three is internal increasing returns present in more than two of the four countries. Evidence of external economies, on the other hand, exists for all four countries, the effects of which are especially strong in France and Belgium.

External effects in U.S. procyclical productivity

Abstract In this paper we highlight a new dimension of the aggregate procyclical productivity phenomenon. We show that estimates of the degree of returns to scale are larger for manufacturing as a whole than for two-digit industries. Since this difference must be due to factors that are only internalized at the most aggregate level, we term it an external effect. This result rules out explanations based on own-input variation —such as true increasing returns and unmeasured factor utilization tied to own-activity —as the sole explanations for aggregate procyclical productivity. We explore several potential explanations of this external effect.

Innovation in Services: Corporate Culture and Investment Banking

The article discusses service innovation in the investment banking industry. Service industry innovations differ from innovations in industries that produce physical products because they rarely have intellectual property and patent protections. However, investment banking services are typically a series of interrelated businesses such as consulting, wealth management and accounting, and innovations require a business wide coordinated approach. The authors argue that a strong corporate culture can support rather than hinder innovation. The creation of such a culture requires strong leadership and an emphasis on innovation in hiring and promotions.

Do currency markets absorb news quickly

Abstract This paper addresses whether macro news arrivals affect currency markets over time. The null from macro exchange rate theory is that they do not: macro news is impounded in exchange rates instantaneously. We test this by examining the effects of news on subsequent trades by end-user participants (such as hedge funds, mutual funds, and non-financial corporations). News arrivals induce subsequent changes in trading in all of the major end-user segments. These induced changes remain significant for days. Induced trades also have persistent effects on prices. Currency markets are not responding to news instantaneously.

Profits and Position Control: A Week of FX Dealing

This paper examines foreign exchange trading at the dealer level. The dealer we track averages

Customer trades and extreme events in foreign exchange

100,000 in profits per day on volume of

Tests of the foreign exchange risk premium using the expected second moments implied by option pricing

1 billion per day (or one basis point). The half-life of the dealers position is only ten minutes, providing strong support for inventory models. A methodological innovation allows us to identify his speculative position over time. This speculative position determines the share of profits deriving from speculation versus intermediation: intermediation is much more important.

Exchange Rate Hysteresis: Large Versus Small Policy Misalignments

Monetary History, Exchange Rates and Financial Markets is an impressive collection of original papers in honour of Charles Goodharts outstanding contribution to monetary economics and policy. Charles Goodhart has written extensively on many of these topics and has become synonymous with his field; the chapters within this book offer a summary of current thinking on his own research subjects and include perspectives on controversies surrounding them.