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Understanding Order Flow

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  • Martin D. D. Evans
  • Richard K. Lyons

Abstract

This paper develops a model for understanding end-user order flow in the FX market. The model addresses several puzzling findings. First, the estimated price-impact of flow from different end-user segments is, dollar-for-dollar, quite different. Second, order flow from segments traditionally thought to be liquidity-motivated actually has power to forecast exchange rates. Third, about one third of order flow's power to forecast exchange rates one month ahead comes from flow's ability to forecast future flow, whereas the remaining two-thirds applies to price components unrelated to future flow. We show that all of these features arise naturally from end-user heterogeneity, in a setting where order flow provides timely information to market-makers about the state of the macroeconomy.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11748.

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Date of creation: Nov 2005
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Publication status: published as Evans, Martin D. D. and Richard K. Lyons. "Understanding Order Flow," International Journal of Finance and Economics, 2006, v11(1,Jan), 3-23.
Handle: RePEc:nbr:nberwo:11748

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  1. Eric van Wincoop & Philippe Bacchetta, 2003. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," NBER Working Papers 9498, National Bureau of Economic Research, Inc.
  2. 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.
  3. Martin D.D. Evans & Richard K. Lyons, 2005. "Meese-Rogoff Redux: Micro-Based Exchange Rate Forecasting," NBER Working Papers 11042, National Bureau of Economic Research, Inc.
  4. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1315-35, November.
  5. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," Working Papers, Duke University, Department of Economics 02-16, Duke University, Department of Economics.
  6. Osler, C. L., 1998. "Short-term speculators and the puzzling behaviour of exchange rates," Journal of International Economics, Elsevier, Elsevier, vol. 45(1), pages 37-57, June.
  7. Harald Hau & Hélène Rey, 2006. "Exchange Rates, Equity Prices, and Capital Flows," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 19(1), pages 273-317.
  8. Martin D. D. Evans & Richard K. Lyons, 2002. "Order Flow and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(1), pages 170-180, February.
  9. Kenneth A. Froot & Tarun Ramadorai, 2002. "Currency Returns, Institutional Investor Flows, and Exchange Rate Fundamentals," NBER Working Papers 9080, National Bureau of Economic Research, Inc.
  10. Evans, Martin D.D. & Lyons, Richard K., 2008. "How is macro news transmitted to exchange rates?," Journal of Financial Economics, Elsevier, Elsevier, vol. 88(1), pages 26-50, April.
  11. Martin Evans and Richard K. Lyons, 2002. "Informational Integration and FX Trading," Working Papers, Georgetown University, Department of Economics gueconwpa~02-02-11, Georgetown University, Department of Economics.
  12. Martin D. D. Evans & Richard K. Lyons, 2007. "Exchange Rate Fundamentals and Order Flow," NBER Working Papers 13151, National Bureau of Economic Research, Inc.
  13. Rime,D., 2000. "Private or public information in foreign exchange markets? : an empirical analysis," Memorandum, Oslo University, Department of Economics 14/2000, Oslo University, Department of Economics.
  14. Engel, Charles & West, Kenneth D., 2003. "Exchange rates and fundamentals," Working Paper Series, European Central Bank 0248, European Central Bank.
  15. 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.
  16. Dunne, Peter & Hau, Harald & Moore, Michael, 2004. "Macroeconomic Order Flows: Explaining Equity and Exchange Rate Returns," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4806, C.E.P.R. Discussion Papers.
  17. Rich Lyons & Martin Evans, 2004. "A New Micro Model of Exchange Rate Dynamics," Econometric Society 2004 North American Winter Meetings 622, Econometric Society.
  18. Kenneth A. Froot & Tarun Ramadorai, 2005. "Currency Returns, Intrinsic Value, and Institutional-Investor Flows," Journal of Finance, American Finance Association, American Finance Association, vol. 60(3), pages 1535-1566, 06.
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