DP6553 Optimal Informed Trading in the Foreign Exchange Market

We formulate a market microstructure model of exchange determination we employ to investigate the impact of informed trading on exchange rates and on foreign exchange (FX) market conditions. With our formulation we show how strategic informed agents influence exchange rates via both portfolio-balance and information effects. We outline the connection which exists between the private value of information, market efficiency, liquidity and exchange rate volatility. Our model is also consistent with recent empirical research on the microstructure of FX markets.