Advanced Search
MyIDEAS: Login

Order Flow and Exchange Rate Dynamics

Contents:

Author Info

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

Abstract

Macroeconomic models of nominal exchange rates perform poorly. In sample, R2 statistics as high as 10 percent are rare. Out of sample, these models are typically out-forecast by a na‹ve random walk. This paper presents a model of a new kind. Instead of relying exclusively on macroeconomic determinants, the model includes a determinant from the field of microstructure-order flow. Order flow is the proximate determinant of price in all microstructure models. This is a radically different approach to exchange rate determination. It is also strikingly successful in accounting for realized rates. Our model of daily exchange-rate changes produces R2 statistics above 50 percent. Out of sample, our model produces significantly better short-horizon forecasts than a random walk. For the DM/$ spot market as a whole, we find that $1 billion of net dollar purchases increases the DM price of a dollar by about 1 pfennig.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w7317.pdf
Download Restriction: no

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7317.

as in new window
Length:
Date of creation: Aug 1999
Date of revision:
Handle: RePEc:nbr:nberwo:7317

Note: AP IFM
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
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.:
as in new window
  1. Evans, George W, 1986. "A Test for Speculative Bubbles in the Sterling-Dollar Exchange Rate: 1981-84," American Economic Review, American Economic Association, vol. 76(4), pages 621-36, September.
  2. Richard K. Lyons., 1993. "Tests of Microstructural Hypotheses in the Foreign Exchange Market," Research Program in Finance Working Papers RPF-230, University of California at Berkeley.
  3. Flood, Mark D., 1994. "Market structure and inefficiency in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 13(2), pages 131-158, April.
  4. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, vol. 77(1), pages 133-53, March.
  5. Meese, R. & Rogoff, K., 1988. "Was It Real? The Exchange Rate-Interest Differential Ralation Over The Modern Floating-Rate Period," Working papers 368, Wisconsin Madison - Social Systems.
  6. Martin D. D. Evans(Georgetown University and NBER), 2005. "What are the Origins of Foreign Exchange Movements?," Working Papers gueconwpa~05-05-06, Georgetown University, Department of Economics.
  7. Payne, Richard, 2003. "Informed trade in spot foreign exchange markets: an empirical investigation," Journal of International Economics, Elsevier, vol. 61(2), pages 307-329, December.
  8. Takatoshi Ito & Richard K. Lyons & Michael T. Melvin, 1996. "Is There Private Information in the FX Market? The Tokyo Experiment," Working Papers _005, University of California at Berkeley, Haas School of Business.
  9. Kathryn M. Dominguez, 1986. "Are foreign exchange forecasts rational? New evidence from survey data," International Finance Discussion Papers 281, Board of Governors of the Federal Reserve System (U.S.).
  10. Yin-Wong Cheung & Menzie D. Chinn, 1999. "Macroeconomic Implications of the Beliefs and Behavior of Foreign Exchange Traders," NBER Working Papers 7417, National Bureau of Economic Research, Inc.
  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, vol. 53(5), pages 1623-1656, October.
  12. Linda Goldberg & Rafael Tenorio, 1995. "Strategic Trading in a Two-Sided Foreign Exchange Auction," NBER Working Papers 5187, National Bureau of Economic Research, Inc.
  13. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  14. Amihud, Yakov & Mendelson, Haim, 1980. "Dealership market : Market-making with inventory," Journal of Financial Economics, Elsevier, vol. 8(1), pages 31-53, March.
  15. Goodhart, Charles A. E. & O'Hara, Maureen, 1997. "High frequency data in financial markets: Issues and applications," Journal of Empirical Finance, Elsevier, vol. 4(2-3), pages 73-114, June.
  16. Fair, Ray C, 1970. "The Estimation of Simultaneous Equation Models with Lagged Endogenous Variables and First Order Serially Correlated Errors," Econometrica, Econometric Society, vol. 38(3), pages 507-16, May.
  17. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  18. Frenkel, Jacob A, 1976. " A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 200-224.
  19. Vogler, Karl-Hubert, 1997. "Risk allocation and inter-dealer trading," European Economic Review, Elsevier, vol. 41(8), pages 1615-1634, August.
  20. Flood, R.P. & Rose, A.K., 1992. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," Papers 529, Stockholm - International Economic Studies.
  21. Kouri, Pentti J K & Porter, Michael G, 1974. "International Capital Flows and Portfolio Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 443-67, May/June.
  22. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," NBER Working Papers 2880, National Bureau of Economic Research, Inc.
  23. R. Dornbusch, 1982. "Equilibrium and Disequilibrium Exchange Rates," Working papers 309, Massachusetts Institute of Technology (MIT), Department of Economics.
  24. Cheung, Yin-Wong & Wong, Clement Yuk-Pang, 2000. "A survey of market practitioners' views on exchange rate dynamics," Journal of International Economics, Elsevier, vol. 51(2), pages 401-419, August.
  25. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  26. Chinn, Menzie David, 1991. "Some linear and nonlinear thoughts on exchange rates," Journal of International Money and Finance, Elsevier, vol. 10(2), pages 214-230, June.
  27. Romer, David, 1993. "Rational Asset-Price Movements without News," American Economic Review, American Economic Association, vol. 83(5), pages 1112-30, December.
  28. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521466004, November.
  29. Kouri, Pentti J K, 1976. " The Exchange Rate and the Balance of Payments in the Short Run and in the Long Run: A Monetary Approach," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 280-304.
  30. Meese, Richard, 1990. "Currency Fluctuations in the Post-Bretton Woods Era," Journal of Economic Perspectives, American Economic Association, vol. 4(1), pages 117-34, Winter.
  31. Foster, F Douglas & Viswanathan, S, 1990. "A Theory of the Interday Variations in Volume, Variance, and Trading Costs in Securities Markets," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 593-624.
  32. Lyons, Richard K., 1996. "Optimal Transparency in a Dealer Market with an Application to Foreign Exchange," Journal of Financial Intermediation, Elsevier, vol. 5(3), pages 225-254, July.
  33. Peter C. Reiss & Ingrid M. Werner, 1998. "Does Risk Sharing Motivate Interdealer Trading?," Journal of Finance, American Finance Association, vol. 53(5), pages 1657-1703, October.
  34. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
  35. Jones, Charles M & Kaul, Gautam & Lipson, Marc L, 1994. "Transactions, Volume, and Volatility," Review of Financial Studies, Society for Financial Studies, vol. 7(4), pages 631-51.
  36. Covrig, Vicentiu & Melvin, Michael, 2002. "Asymmetric information and price discovery in the FX market: does Tokyo know more about the yen?," Journal of Empirical Finance, Elsevier, vol. 9(3), pages 271-285, August.
  37. Goodhart, Charles, 1988. "The Foreign Exchange Market: A Random Walk with a Dragging Anchor," Economica, London School of Economics and Political Science, vol. 55(220), pages 437-60, November.
  38. Osler, C. L., 1998. "Short-term speculators and the puzzling behaviour of exchange rates," Journal of International Economics, Elsevier, vol. 45(1), pages 37-57, June.
  39. David A. Hsieh & Allan W. Kleidon, 1996. "Bid-Ask Spreads in Foreign Exchange Markets: Implications for Models of Asymmetric Information," NBER Chapters, in: The Microstructure of Foreign Exchange Markets, pages 41-72 National Bureau of Economic Research, Inc.
  40. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729 Elsevier.
  41. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, vol. 9(1), pages 47-73, March.
  42. Shang-Jin Wei & Jungshik Kim, 1999. "The Big Players in the Foreign Exchange Market: Do They Trade on Information or Noise?," CID Working Papers 5, Center for International Development at Harvard University.
  43. Lyons, Richard K., 1997. "A simultaneous trade model of the foreign exchange hot potato," Journal of International Economics, Elsevier, vol. 42(3-4), pages 275-298, May.
  44. Grinblatt, Mark & Titman, Sheridan & Wermers, Russ, 1995. "Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior," American Economic Review, American Economic Association, vol. 85(5), pages 1088-1105, December.
  45. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-18, March.
  46. Hans R. Stoll, . "The Supply of Dealer Services in Securities Markets," Rodney L. White Center for Financial Research Working Papers 02-78, Wharton School Rodney L. White Center for Financial Research.
  47. Torben G. Andersen & Tim Bollerslev, 1998. "Deutsche Mark-Dollar Volatility: Intraday Activity Patterns, Macroeconomic Announcements, and Longer Run Dependencies," Journal of Finance, American Finance Association, vol. 53(1), pages 219-265, 02.
  48. Hau, Harald, 1998. "Competitive Entry and Endogenous Risk in the Foreign Exchange Market," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 757-87.
  49. Scholes, Myron S, 1972. "The Market for Securities: Substitution versus Price Pressure and the Effects of Information on Share Prices," The Journal of Business, University of Chicago Press, vol. 45(2), pages 179-211, April.
  50. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
  51. DeGennaro, Ramon P. & Shrieves, Ronald E., 1997. "Public information releases, private information arrival and volatility in the foreign exchange market," Journal of Empirical Finance, Elsevier, vol. 4(4), pages 295-315, December.
  52. Blanchard, Olivier Jean, 1979. "Speculative bubbles, crashes and rational expectations," Economics Letters, Elsevier, vol. 3(4), pages 387-389.
  53. Flood, Robert P & Hodrick, Robert J, 1990. "On Testing for Speculative Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 85-101, Spring.
  54. Isard,Peter, 1995. "Exchange Rate Economics," Cambridge Books, Cambridge University Press, number 9780521460477, November.
  55. Richard K. Lyons., 1997. "Profits and Position Control: A Week of FX Dealing," Research Program in Finance Working Papers RPF-273, University of California at Berkeley.
  56. Richard K. Lyons, 2006. "The Microstructure Approach to Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 026262205x, January.
  57. Shleifer, Andrei, 1986. " Do Demand Curves for Stocks Slope Down?," Journal of Finance, American Finance Association, vol. 41(3), pages 579-90, July.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is featured on the following reading lists or Wikipedia pages:

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:7317. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.