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Exchange rate forecasting, order flow and macroeconomic information

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Author Info
Dagfinn Rime () (Norges Bank (Central Bank of Norway))
Lucio Sarno () (Universty of Warwick and CEPR)
Elvira Sojli () (Universty of Warwick)

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Abstract

This paper investigates the empirical relation between order flow and macroeconomic information in the foreign exchange market, and the ability of microstructure models based on order flow to outperform a naive random walk benchmark. If order flow reflects heterogeneous beliefs about macroeconomic fundamentals, and currency markets learn about the state of the economy gradually, then order flow can have both explanatory and forecasting power for exchange rates. Using one year of high frequency data for three major exchange rates, we demonstrate that order flow is intimately related to a broad set of current and expected macroeconomic fundamentals. More importantly, we find that order flow is a powerful predictor of daily movements in exchange rates in an out-of-sample exercise. The Sharpe ratio obtained from allocating funds using forecasts generated by an order flow model is generally above unity and substantially higher than the Sharpe ratios obtained from alternative models, including the random walk model.

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Publisher Info
Paper provided by Norges Bank in its series Working Paper with number 2007/02.

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Length: 43 pages
Date of creation: 20 Apr 2007
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Handle: RePEc:bno:worpap:2007_02

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Related research
Keywords: Exchange rate; Microstructure; Order flow; Forecasting; Macroeconomic news.;

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Nikola Gradojevic & Christopher J. Neely, 2008. "The dynamic interaction of order flows and the CAD/USD exchange rate," Working Papers 2008-006, Federal Reserve Bank of St. Louis. [Downloadable!]
  2. Mario Cerrato & Nicholas Sarantis & Alex Saunders, 2009. "An investigation of customer order flow in the foreign exchange market," Working Papers 2009_25, Department of Economics, University of Glasgow. [Downloadable!]
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