Speculative noise trading and manipulation in the foreign exchange market

We investigate the possibility that in the foreign exchange market uninform ed speculators find it convenient to trade on noise in order to gain an inf ormational advantage they can exploit in future. In a two-period model, we analyze the trade-off between the cost of the "informational investment" an d the profits this brings about, studying the optimal manipulation strategy under different hypotheses on the activity of market participants. Our res ults give a possible explanation for the presence of noise trading in the f oreign exchange market. (C) 2000 Elsevier Science Ltd. All rights reserved. JEL classification: D82; G14; G15.