Staff Working Paper No. 964
By Robert Czech, Pasquale Della Corte, Shiyang Huang and Tianyu WangWe study the information content of foreign exchange (FX) option volume using a unique dataset on over-the-counter FX options with disclosed counterparty identities and contract characteristics. Our study shows that FX option volume can predict future exchange rate returns, especially when the demand for the US dollar is high. In support of information-based arguments, we also document that the exchange rate predictability is stronger around macro-announcement days or when using options with higher embedded leverage. Finally, we show that hedge funds and real money investors have superior skills in predicting future exchange rates compared to other investor types.