9th Symposium on Finance, Banking, and Insurance
Universität Karlsruhe (TH), Germany, December 11 - 13, 2002

Abstract

The Determinants of Trading Volume:
Information Flow and Inventory Control

José M Carrera
Peter F Pope
Stephen J Taylor

Banco de México
Department of Accounting and Finance, Lancaster University

The growing amounts of trading volume in the foreign exchange market seems to be difficult to explain in terms of changes in macroeconomic fundamentals or information arrival, raising difficulties with the efficient market hypothesis. Specially, it is not clear what forces determine trading volume itself. We document, for the first time, time series properties of the components of trading volume for an entire currency market. Although small, the Mexican market provides us with a clear picture of the components of trading volume. Specifically, we document the extent of inter­dealer trading among Mexican banks and its two basic components: undesired inventories and inventory rebalancing. To address the issue of inter­dealer trading, we empirically test for its determinants. Our simple specification nests some of the most common arguments in the literature for the sources of trading volume: differential information, or difference in opinion and the accumulation of information and trade. In addition, we test the hypothesis that inter­dealer trading depends on how easy is to find counterparts to settle undesired inventories. We find empirical support for them.