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A Guided Tour of the Market Microstructure Approach to Exchange Rate Determination

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  • Vitale, Paolo

Abstract

We propose a critical review of recent developments in exchange rate economics. This new strand of research is motivated by some very stark empirical evidence, relating exchange rate returns to order flow. Plenty of empirical evidence shows that order flow, i.e. the imbalance in the sequence of purchases and sales of foreign currencies in the markets for foreign exchange, is an extremely powerful determinant of short-run exchange rate movements. With a simplified analytical framework we see how, according to the rational expectation paradigm of asset pricing, such a relation reflects liquidity and information effects of portfolios shifts.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4530.

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Date of creation: Aug 2004
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Handle: RePEc:cpr:ceprdp:4530

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Keywords: exchange rate dynamics; foreign exchange microstructure; order flow;

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Cited by:
  1. Vitale, Paolo, 2006. "A market microstructure analysis of foreign exchange intervention," Working Paper Series 0629, European Central Bank.
  2. Müller-Plantenberg, Nikolas A., 2010. "Balance of payments accounting and exchange rate dynamics," International Review of Economics & Finance, Elsevier, vol. 19(1), pages 46-63, January.
  3. Michael Frömmel & Norbert Kiss M. & Klára Pintér, 2011. "Macroeconomic announcements, communication and order flow on the Hungarian foreign exchange market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 16(2), pages 172-188, 04.
  4. Müller-Plantenberg, Nikolas, 2012. "Balance of payments flows and exchange rate prediction in Japan," Working Papers in Economic Theory 2012/09, Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History).
  5. Michael R. King & Carol Osler & Dagfinn Rime, 2013. "The market microstructure approach to foreign exchange - Looking back and looking forward," Working Paper 2013/12, Norges Bank.
  6. Antonio Scalia, 2006. "Is foreign exchange intervention effective? Some micro-analytical evidence from the Czech Republic," Temi di discussione (Economic working papers) 579, Bank of Italy, Economic Research and International Relations Area.
  7. Müller-Plantenberg, Nikolas, 2012. "Boom-and-bust cycles marked by capital inflows, current account deterioration and a rise and fall of the real exchange rate," Working Papers in Economic Theory 2012/10, Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History).

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