During the trading period dealers get real time information, through electronic screens, about public news announcements as well as other banks quoting activity. The latter constitutes the only information that a bank has about other banks’ quotes. DeGennaro and Shrieves (1997) and Bauwens, Ben Omrane, and Giot (2003) use quoting activity adjusted from its seasonal component as a proxy for private information occurring from customers’ order flow. Consequently, dealers can try to infer other dealers’ private information or reaction to news announcements through their quoting activity.

Hence, dealers could use two information channels to build their reaction to news events. The first channel takes place directly through the news broadcasters. In such a case dealers react directly to the news announcements. The second channel, which could be a source of noise to the first one, is the quoting activity of the other dealers. In the first subsection we present a literature review on news announcements and quoting activity measures. In the second one, we provide a summary of a relatively new literature which has been concerned with the analysis of individual banks. Drawing on this, in the third subsection we formulate the questions that we investigate.

News Announcements and Quoting Activity

News announcements and quoting activity were analysed in several studies. DeGennaro and Shrieves (1997) use three categories of news announcements (scheduled and unscheduled macroeconomic news announcements as well as interest rate reports) and six different periods around the event and analyse their impact on quoting activity. They find a significant effect of all three categories of news, but at different times relative to the announcement. Melvin and Yin (2000) work with a sample of US Dollar/Japanese Yen and US Dollar/Deutche Mark data from December 1993 to April 1995 in hourly data. They take as news variable the number of news events that happen within an hour and do not make any distinction between different categories of news.

They find a significant impact of news on quoting activity, working with deseasonalised variables, and conclude that quoting activity is not self-generating. Evans and Lyons (2003) identify two channels of transmission of macro news to exchange rates: a direct effect and an indirect effect via the order flows. The news variable is the number of news announcements that occur within the period. Identification of the various effects is done by the imposition of orthogonality conditions on the various innovation terms in the model and estimation is carried out using the generalized method of moments (GMM). Changes in midquotes are regressed on order flow with two error terms, one with a constant variance, which represents information directly impounded into prices, another whose variance depends on the number of information events and represents the common knowledge effect of macro news on the exchange rate.

The order flow is also the sum of two shocks, one of whose variance depends on news. This shock is interpreted as the indirect effect of news on exchange rates via induced order flow. In order to justify that macroeconomic news affects order flow, Evans and Lyons (2003) mention differences in interpretation of the news or differences in opinion as regards to the impact of the news on the exchange rate. Several studies have taken the number of banks quotes as a proxy for the number of transactions, which is tantamount to assuming that a fixed proportion of posted quotes correspond to actual trades.

This assumption has been made, amongst others, by Goodhart and Figliuoli (1991) and Bollerslev and Domowitz (1993), who prefer to use quote arrival as a proxy for market activity, than transaction volume, because quotes signal a willingness to trade. DeGennaro and Shrieves (1997) use the same assumption, as they consider the seasonal and stochastic parts of quoting activity to be a proxy for the expected and surprise components of market activity. Furthermore, their results are suggestive of the fact that the surprise part of market activity reflects informed trading.

Melvin and Yin (2000) have made the same assumption. In the taxonomy of Evans (2002), different interpretations of the same news are classified as non-common knowledge (NCK) information, as opposed to common knowledge (CK) news, which corresponds to news that is available simultaneously to all market participants and is interpreted in the same way. He considers, instead of an equilibrium price, an equilibrium price distribution. He justifies this by the lack of transparency of currency markets, which makes it possible for several transactions to happen simultaneously at different prices. This can also be understood, if one considers that different dealers have different interpretations of the events that influence the exchange rate.

His result suggests that CK news is not the predominant source of long term movements in the exchange rate. In the empirical part, based on prices and order flow, CK and NCK shocks are identified by the assumption that CK news leads to an immediate one-for-one change in the mean of the equilibrium price and have no effect on order flow, whereas NCK news has an impact both on prices and order flow, which may take time.

Inter-dealer Interaction

A relatively new literature has been concerned with the analysis of individual banks. In this strand of the literature papers deal mainly with the identification of price leaders in the market around central bank interventions, but also in normal trading. Peiers (1997) analyses the midquotes of several banks on the Dollar/Mark exchange rate around the European Central Bank interventions using a vector autoregression (VAR) model and Granger causality tests to identify the price leading bank. The sample of banks includes Deutsche Bank, Soci´et´e G´en´erale, Chemical Bank, Rabobank, Den Norske and BHF Bank. Deutsche Bank is the first to react, 60 minutes prior to the announcement, followed by other banks, 25 minutes before the announcement. Wang (2001) and Sapp (2002) instead use cointegration analysis.

They focus on a small subset of banks and analyse their midquotes with a cointegrated VAR model. The midquotes of all the banks are integrated of order one (I(1)) and they cannot deviate in the long run, which means that they are cointegrated. The number of cointegrating relationships is equal to the number of banks minus one, which means that there is only one stochastic trend driving the system, which can therefore be interpreted as the fundamental market price. Wang (2001) analyses price leadership amongst three leading New York-based dealers on the US Dollar/Deutche Mark market: J.P. Morgan, Chemical Bank and Citibank. Sapp (2002) works on the same market and estimates a cointegrated VAR system and deduces measures of information shares, for all the trading period as well as around central bank interventions. This is used to identify the banks whose information share is largest around central bank interventions.

Objectives of the Study

We investigate the simultaneous effect of news announcements and individual banks’ quoting activity on the quoting activity of FX dealers. We measure quoting activity by the number of quotes in a given time interval and we analyse it through a multivariate count model. The object of the study can be summarized in four points. The first one is to study the sensitivity of dealers’ quoting activity to some categories of public announcements. Some dealers could increase their quoting activity whilst others could decrease it or keep it unchanged on response to the same news. Raising quoting activity implies boosting quote revision, which increases the price volatility.

The second point is to analyse different reactions of banks to the same news announcement. Thus far there has been to the best of our knowledge, no work on the response of individual banks’ quoting activity to news. DeGennaro and Shrieves (1997) regress quoting activity on news and find a significant impact of certain types of news announcements. In our analysis we allow for different responses of individual banks to the same news and we compare the results to those of the aggregate level. The third point is to classify different categories of news announcement into two groups. Using the definitions of CK and NCK suggested by Evans (2002) and following the literature which takes the quoting activity as a proxy for the number of transactions, allows us to classify news announcements according to whether they impact quoting activity or not.

If they do not, this means that they can be considered as CK news events, whereas public announcements, that have quoting activity implications, do so maybe because of heterogeneous interpretation by dealers. Indeed some banks might have different degrees of understanding of the same news, which can lead them to act on their anticipations or to stay away from the market, waiting for better-informed banks to act first. The last point consists in demonstrating how dealers observe quoting activity of others to infer useful information like private information held by other dealers or their reaction to public news announcements.

If a dealer increases (decreases) his quoting activity following the publication of news this means that he enhances (reduces) his price revision. His response could be biased when he is sensitive to other dealers’ reactions. It means that his quoting activity could be amplified in the positive or negative ways. On the other hand, a public news announcement could have no effect on a dealers’ quoting activity maybe because he considers that such news as irrelevant or he is sensitive to another one who does not react to the same news. In such a case, quoting activity could be a useful information channel which foreign exchange dealers rely on.

By Dr W. B. Omrane and A. Heinen

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Summary: Index