Public Information Arrival, Exchange Rate Volatility, and Quote Frequency

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Abstract
We examine the role of public information arrival as a determinant of exchange rate volatility in a microstructure setting capturing the 24-hour nature of the foreign exchange market. The mixture of distributions model is used to motivate the link between information arrival and volatility. Where past studies have used volume data from the stock market to infer information arrival, we explicitly measure the arrival of public information using Reuters Money-Market Headline News. Before model estimation can be executed, the intradaily seasonality in the data must be treated. There is a pronounced pattern in each business day that mirrors the opening and closing of major market centers. We use seasonally-adjusted data for hypothesis testing. The exchange rate data are tick-by-tick data on the German mark and Japanese yen against the U.S. dollar. The evidence suggests that the volatility of the exchange rates is independent of the rate of information arrival to the market unless seasonally-unadjusted data are used. However, in the most direct application of the mixture of distributions model, the number of quotes (price revisions) on both currencies appears to be a function of information arrival. Overall, the evidence indicates that when there is more than the normal amount of public information, there is more than the normal amount of quoting activity so public information arrival plays an important role in the evolution of the pace of market activity. The lack of a volatility effect may indicate that private information is an important source of volatility. The results have mixed implications for the debate over regulation of the foreign exchange market and proposals to "throw sand in the wheels of international finance." The positive link between public information arrival and quote frequency suggests that foreign exchange market activity is not largely self- generating and indicates that trading is likely providing the function it is meant to provide--adj
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