Customer Order Flow and Exchange Rate Movements : Is There Really Information Content?

In this paper, we analyze the information content of the customer order flow seen by a leading European commercial bank's foreign exchange desk. We attempt to distinguish between three different explanations given in the literature for the positive contemporaneous correlation between exchange rate changes and net order flows. We discount the liquidity effect since otherwise equivalent order flows from different counterparties have different correlations with exchange rate changes. While it is harder to discount the feedback trading explanation, we find evidence that a measure of the degree of informedness of customers widely used in the equity microstructure literature closely corresponds to the size of the correlation between order flow and exchange rate changes. We argue that customer order flows do contain information