TESTS OF MICROSTRUCTURAL HYPOTHESES IN THE FOREIGN-EXCHANGE MARKET

Data in this paper support both the inventory-control and asymmetric-i nformation approaches to microstructure theory. Strong evidence of an inventory-control effect on price is new. The transactions dataset chr onicles a trading week of a spot foreign exchange dealer whose daily v olume averages over $1 billion. In addition to controlling inventory w ith his own price, the dealer also lays off inventory at other dealers ' prices and through brokers. These results highlight the importance o f inventory-control theory in understanding trading in this market.