2007) “Marketwide Private Information in Stocks: Forecasting Currency Returns,” forthcoming Journal of Finance

We present a model of equity trading with informed and uninformed investors where informed investors act upon firm-specific private information and marketwide private in-formation. The model is used to structurally identify the component of order flow that is due to marketwide private information. Estimated trades driven by marketwide private information display very little or no correlation with the first principal component in order flow. This finding implies that a simple statistical factor of order flow is a poor measure of marketwide private information. Moreover, the model suggests that the previously docu-mented co-movement in order flow captures mostly variation in liquidity trades. Marketwide private information obtained from equity market data forecasts industry stock returns. It also forecasts foreign exchange returns consistent with Evans and Lyons ’ (2004a) model of exchange rate determination. JEL Classification: F31, G11, G14