Informational integration and FX trading

This paper addresses international financial integration in a new way. We focus on informational integration, specifically, the importance of information conveyed by order flow in major currencies for pricing minor currencies. We develop a multi-currency model of portfolio allocation in the presence of dispersed information. We then test the model's implications using four months of concurrent transaction data on nine currencies. The model explains 45 to 78% of daily returns in all nine currencies. Moreover, its prediction that order flow in individual markets should be relevant for determining prices in other markets is home out. (C) 2002 Elsevier Science Ltd. All rights reserved.