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Order Flow in the South: Anatomy of the Brazilian FX Market

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  • Wu, Thomas

Abstract

Using a unique dataset that covers 100% of the Brazilian FX retail market, this paper contributes to the microstructure approach to exchange rates in at least four ways. First, we find a strict link between currency flows in the FX market and the Balance of Payments. Second, we develop an identication strategy in order to properly estimate the effect of customer order fl?ows on the exchange rate and ?find that dealers from the Brazilian FX market charge a premium of 0.03% in order to provide US$ 10 million of overnight liquidity. Third, we identify the nature of the feedback trading as "stabilizing"?: a 1% depreciation rate decreases the financial customer fl?ow by US$ 111 million and the commercial fl?ow by US$ 46 million. Finally, we find that the central bank sells in average US$ 28 million for each 1% depreciation in the exchange rate (lean-against-the-wind), and US$ 23 million for US$ 100 million of financial customer flow (liquidity provision).

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Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt1k2250wj.

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Date of creation: 07 Nov 2006
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Handle: RePEc:cdl:ucscec:qt1k2250wj

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  1. Hau, Harald & Rey, Hélène, 2003. "Exchange Rates, Equity Prices and Capital Flows," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3735, C.E.P.R. Discussion Papers.
  2. M. Beine & A. Bénassy-Quéré & E. Dauchy & R. MacDonald, 2002. "The Impact of Central Bank Intervention on Exchange-Rate Forecast Heterogeneity," THEMA Working Papers, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise 2002-22, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  3. Payne, Richard, 2003. "Informed trade in spot foreign exchange markets: an empirical investigation," Journal of International Economics, Elsevier, Elsevier, vol. 61(2), pages 307-329, December.
  4. Kathryn M. E. Dominguez, 2003. "When Do Central Bank Interventions Influence Intra-Daily and Longer-Term Exchange Rate Movements?," Working Papers, Research Seminar in International Economics, University of Michigan 506, Research Seminar in International Economics, University of Michigan.
  5. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
  6. Geir Høidal Bjønnes & Dagfinn Rime & Haakon O. Aa. Solheim, 2004. "Liquidity provision in the overnight foreign exchange market," Discussion Papers, Research Department of Statistics Norway 391, Research Department of Statistics Norway.
  7. Hoidal Bjonnes, Geir & Rime, Dagfinn, 2003. "Dealer Behavior and Trading Systems in Foreign Exchange Markets," SIFR Research Report Series, Institute for Financial Research 17, Institute for Financial Research.
  8. Evans, Martin D. & Lyons, Richard K., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance, Working Paper Series, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley qt0dh1c16w, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
  9. Hasbrouck, Joel, 1991. "The Summary Informativeness of Stock Trades: An Econometric Analysis," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 4(3), pages 571-95.
  10. Lyons, Richard K., 1997. "A simultaneous trade model of the foreign exchange hot potato," Journal of International Economics, Elsevier, Elsevier, vol. 42(3-4), pages 275-298, May.
  11. Oliver Hansch & Narayan Y. Naik & S. Viswanathan, 1998. "Do Inventories Matter in Dealership Markets? Evidence from the London Stock Exchange," Journal of Finance, American Finance Association, American Finance Association, vol. 53(5), pages 1623-1656, October.
  12. Carol L. Osler, 2003. "Currency Orders and Exchange Rate Dynamics: An Explanation for the Predictive Success of Technical Analysis," Journal of Finance, American Finance Association, American Finance Association, vol. 58(5), pages 1791-1820, October.
  13. Kenen,Peter B., 2000. "The International Economy," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521644358.
  14. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, American Finance Association, vol. 46(1), pages 179-207, March.
  15. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, Elsevier, vol. 22(3), pages 477-498, June.
  16. Richard Payne, 2001. "A Transaction Level Study of the Effects of Central Bank Intervention on Exchange Rates," FMG Discussion Papers, Financial Markets Group dp355, Financial Markets Group.
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Cited by:
  1. Esen Onur, 2008. "The role of asymmetric information among investors in the foreign exchange market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 13(4), pages 368-385.

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