Marketwide Private Information in Stocks: Forecasting Currency Returns

Abstract

We present a model of equity trading with informed and uninformed investors where informed investors trade on firm-specific and marketwide private information. The model is used to identify the component of order flow due to marketwide private information. Estimated trades driven by marketwide private information display little or no correlation with the first principal component in order flow. Indeed, we find that comovement in order flow captures variation mostly in liquidity trades. Marketwide private information obtained from equity market data forecasts industry stock returns, and also currency returns.

Keywords: Marketwide private information, firm-specific private information, order flow, principal components, currency returns, equity returns

JEL Classification: F31, G11, G14