Essays on the microstructure of foreign exchange markets

While central banks intervene on a frequent and substantial basis in foreign exchange markets, the mechanism by which traders interpret the signal conveyed by interventions remains a puzzle. The first chapter uses a Bayesian asymmetric information framework to disentangle the process by which central bank order-flow signals are disseminated in the market. Traders' perceptions about fundamentals along with their interpretation of intervention signals yield varying implications for the pricing responses of market participants. The paper tests these implications with an ordered probit model to uncover the impact of intervention announcements in the Yen/Dollar market using high frequency (intra-day) spot rate data. I find strong evidence of greater market uncertainty following central bank trading activity, with increases in spot rate volatility and a widening of individual market maker bid-ask spreads.; The second chapter examines the empirical behavior of real exchange rates across three distinct nominal exchange rate regimes in Europe within a framework of changing trade regimes. First, cross-section time-series properties of real exchange rates through panel data analysis reveal strong support for a decrease in real exchange rate variability when nominal rates are managed rather than freely floating. Second, spectral density estimates show that although we cannot reject the null of a unit root using traditional tests of non-stationarity, real exchange rates display a substantial negative auto-correlation at later lags and hence a long term mean reverting component under the ERM arrangements. We conclude that by influencing the long term behavior of real exchange rates, nominal exchange rate policies in conjunction with trade policies have important implications for the real side of the economy.; The third chapter tests the cross market linkages and geographic segmentation in the foreign exchange market in response to the arrival of macro-economic news. I characterize the behavior of DM/{dollar} quotes (spreads, volatility, quote frequency) from banks physically located in Europe versus the United States in response to the arrival of news about the German or American economies. In particular, the focus is on the overlap period in the interbank spot market for foreign exchange located in Frankfurt and New York. The data show strong intra-daily seasonality in activity patterns across regional segments of the spot market. Vector auto-regression estimates are then used to disentangle own and cross market linkages following the arrival of public information. The results support the hypothesis that geographic segmentation plays a role in currency markets despite trading an apparently identical asset suggesting differences between local and foreign trader perceptions about the domestic currency.