The Tokyo experiment: description

The Tokyo experiment addresses a key motive for FX trading: informational advantages. The experiment is based on a simple fact: in general, volatility is much higher over periods of continual trading than over otherwise similar periods that contain a closure. Why should this be so? Three possible explanations have been proposed: (1) publicly available information, like a macroeconomic announcement, arrives primarily during trading hours and therefore affects price at that time; (2) errors in pricing may be more likely during trading hours; and (3) some people may be trading on information that is not publicly available, thereby affecting price during trading hours.

To discriminate among these explanations, an insightful paper by French and Roll (1986) examined stock market closures. These closures were special, however: they occurred on what otherwise would have been normal trading days, and the cause of the closures-bookkeeping backlogs-had nothing to do with the rest of the economy. Thus, the flow of publicly available information on these days was the same as on normal trading days (as compared to, say, a holiday). They found that volatility over periods spanning these closures decreases. Since this cannot be due to a changing flow of public information, they turned to the other two possible explanations. After finding only a small role for pricing errors, they concluded that some type of information about equities that is not publicly available is the main source of high trading-time volatility.

To perform a French-Roll type analysis on the foreign exchange market one needs an experiment like theirs, namely, open and closed periods that do not differ in the flow of public information. The lifting of the trading restriction in Tokyo is just such an experiment. Three key facts support the possibility that the flow of public information remained unchanged. First, abolishing the trading restriction was not part of a broader policy reform, nor was it the work of the Ministry of Finance; rather, it was an isolated change in regime, unlikely to be correlated with Ministry of Finance policy more generally. Second, reviewing the schedule of relevant macroeconomic announcements in the subsequent months shows that no change over the lunch hour occurred. Third, the timing of some public information is endogenous and may be affected by trading rules (an issue that arises in the French-Roll paper as well since their closures were known in advance). However, an examination of the flow of news reports on the Money Market Headline News screen, a measure of public information flow commonly used by analysts, suggests that the number did not increase after lifting the restriction. Thus, the usual measures indicate that the flow of public information remained unchanged.