5. Concluding remarks
We have argued that investors’ private information related to the stock market helps explain the observed exchange rate fluctuations. We tested this proposition using daily-frequency data from three financial markets in Thailand, and we found strong evidence in favor of the proposition. To paraphrase a famous dictum of Animal Farm (Orwell, 1945), some capital flows are more equal than others: Only the relatively small portion of FX order flow that is driven by investors’ transactions in the stock market has a lasting statistical impact on the exchange rate. Given that the serial correlation patterns present in the observed flows in the stock and FX markets are consistent with private information asymmetries between domestic and for eign investors, we inferred that the reason why stock market-induced capital flows have a lasting effect on the exchange rate is that they convey investors’ private information. We also found that the much larger portion of FX order flow that is not explained by stock market variables played at most a transitory role in determining the exchange rate. Taken together, these findings strongly suggest that FX order flow is relevant for the exchange rate if it is based on and conveys investors’ private information about the prospects of individual firms and the corporate sector as a whole.
