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Order flow in the South: Anatomy of the Brazilian FX market

  • Wu, Thomas
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    This paper analyses one of the main pillars of Brazil's newly found economic resilience: a maturing FX market providing support to its managed floating exchange rate regime. I develop a microstructure model suitable to describe the Brazilian FX market, an emerging economy frequently subjected to sudden stops in capital flows. The model introduces two major changes relative to previous microstructure models. First, dealers may decide to hold overnight positions in the FX market if they find it profitable to do so. Second, customers’ demand for foreign exchange is a function of macroeconomic fundamentals, including contemporaneous feedback from exchange rate movements. The main predictions of the model are supported by a unique data set, covering all transactions between dealers and customers from the official Brazilian FX market from July 1, 1999 to June 30, 2003 (a time period in which Brazil suffered two severe external liquidity shocks).

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    File URL: http://www.sciencedirect.com/science/article/pii/S1062940812000320
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    Article provided by Elsevier in its journal The North American Journal of Economics and Finance.

    Volume (Year): 23 (2012)
    Issue (Month): 3 ()
    Pages: 310-324

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    Handle: RePEc:eee:ecofin:v:23:y:2012:i:3:p:310-324
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620163

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    1. William P. Killeen & Richard K. Lyons & Michael J. Moore, 2001. "Fixed versus Flexible: Lessons from EMS Order Flow," NBER Working Papers 8491, National Bureau of Economic Research, Inc.
    2. 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.
    3. Rime, Dagfinn & Sarno, Lucio & Sojli, Elvira, 2010. "Exchange rate forecasting, order flow and macroeconomic information," Journal of International Economics, Elsevier, vol. 80(1), pages 72-88, January.
    4. Esen Onur, 2008. "The role of asymmetric information among investors in the foreign exchange market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(4), pages 368-385.
    5. Cheung, Yin-Wong & Chinn, Menzie & Garcia Pascual, Antonio, 2003. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," Santa Cruz Center for International Economics, Working Paper Series qt5fc508pt, Center for International Economics, UC Santa Cruz.
    6. Kenneth A. Froot & Tarun Ramadorai, 2005. "Currency Returns, Intrinsic Value, and Institutional-Investor Flows," Journal of Finance, American Finance Association, vol. 60(3), pages 1535-1566, 06.
    7. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
    8. Geir Høidal Bjønnes & Dagfinn Rime & Haakon O. Aa. Solheim, 2004. "Liquidity provision in the overnight foreign exchange market," Discussion Papers 391, Statistics Norway, Research Department.
    9. Martin D. D. Evans and Richard K. Lyons., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance Working Papers RPF-288, University of California at Berkeley.
    10. Michael Sager & Mark P. Taylor, 2008. "Commercially Available Order Flow Data and Exchange Rate Movements: "Caveat Emptor"," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 583-625, 06.
    11. Gabriele Galati & Piti Disyatat, 2005. "The effectiveness of foreign exchange intervention in emerging market countries: evidence from the Czech koruna," BIS Working Papers 172, Bank for International Settlements.
    12. Harald Hau, 2001. "Location Matters: An Examination of Trading Profits," Journal of Finance, American Finance Association, vol. 56(5), pages 1959-1983, October.
    13. 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.
    14. 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.
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