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Order Flow and Exchange Rate Dynamics in Brazil

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  • Otavio De Medeiros

    (Universidade de Brasilia, Brazil)

Abstract

The paper presents results of empirical tests with hybrid nominal exchange rate models for the Brazilian foreign exchange market, using macroeconomic and market microstructure variables. The basic model was originally proposed and tested in the German (DM/US$) and the Japanese (¥/US$) foreign exchange markets by Evans and Lyons (2002). We applied the model to the Brazilian foreign exchange market (R$/US$) and obtained significant and correctly signaled coefficients, but the regressions showed low R2s, suggesting the omission of relevant variable(s). The inclusion of an additional variable representing a country-risk premium results significant and increases R2. Estimation by GARCH further improves previous results obtained by OLS. The upshot indicates that the route proposed by Evans and Lyons is a promising explanation for the R$/US$ exchange rate, but it seems the model specification needs further improvement.

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File URL: http://128.118.178.162/eps/fin/papers/0503/0503019.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0503019.

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Length: 10 pages
Date of creation: 16 Mar 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0503019

Note: Type of Document - pdf; pages: 10
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Web page: http://128.118.178.162

Related research

Keywords: exchange rate; market microstructure; country risk; order flow; Brazil;

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References

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  1. Evans, Martin D. & Lyons, Richard K., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance, Working Paper Series qt0dh1c16w, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
  2. 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.
  3. Cheung, Yin-Wong & Chinn, Menzie David & Garcia Pascual, Antonio, 2003. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," Santa Cruz Department of Economics, Working Paper Series qt12z9x4c5, Department of Economics, UC Santa Cruz.
  4. Charles Engel & Kenneth D. West, 2004. "Exchange Rates and Fundamentals," NBER Working Papers 10723, National Bureau of Economic Research, Inc.
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  6. Daniel L. Thornton, 1989. "Tests of covered interest rate parity," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 55-66.
  7. 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.
  8. Christensen, Michael, 2000. "Uncovered Interest Parity and Policy Behavior New Evidence," Finance Working Papers 00-2, University of Aarhus, Aarhus School of Business, Department of Business Studies.
  9. Jeffrey A. Frankel & Andrew K. Rose, 1994. "A Survey of Empirical Research on Nominal Exchange Rates," NBER Working Papers 4865, National Bureau of Economic Research, Inc.
  10. Mark P. Taylor & Ronald MacDonald, 1991. "Exchange Rate Economics: A Survey," IMF Working Papers 91/62, International Monetary Fund.
  11. Eaton, Jonathan & Turnovsky, Stephen J, 1983. "Covered Interest Parity, Uncovered Interest Parity and Exchange Rate Dynamics," Economic Journal, Royal Economic Society, vol. 93(371), pages 555-75, September.
  12. 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.).
  13. Guy Meredith & Menzie D. Chinn, 1998. "Long-Horizon Uncovered Interest Rate Parity," NBER Working Papers 6797, National Bureau of Economic Research, Inc.
  14. 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.
  15. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
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  17. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  18. Flood, R.P. & Rose, A.K., 1992. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," Papers 529, Stockholm - International Economic Studies.
  19. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  20. 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.
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  22. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  23. Frédéric Karamé & Lise Patureau & Thepthida Sopraseuth, 2002. "Can We Beat the Random Walk Forecasts of Out-of-Sample Exchange Rates? A Structural Approach," Computing in Economics and Finance 2002 233, Society for Computational Economics.
  24. Menzie D. Chinn & Guy Meredith, 2005. "Testing Uncovered Interest Parity at Short and Long Horizons during the Post-Bretton Woods Era," NBER Working Papers 11077, National Bureau of Economic Research, Inc.
  25. Thomas Fullerton & Miwa Hattori & Cuauhtémoc Calderón, 2001. "Error correction exchange rate modeling: Evidence for Mexico," Journal of Economics and Finance, Springer, vol. 25(3), pages 358-368, September.
  26. Christensen, Michael, 2000. "Uncovered interest parity and policy behavior: new evidence," Economics Letters, Elsevier, vol. 69(1), pages 81-87, October.
  27. Richard K. Lyons, 2006. "The Microstructure Approach to Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 026262205x, December.
  28. 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.
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