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Understanding order flow

  • Martin D. D. Evans

    (Georgetown University and NBER, USA)

  • Richard K. Lyons

    (U.C. Berkeley and NBER, USA)

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 1 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 macro-economy. Copyright © 2006 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.287
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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 11 (2006)
Issue (Month): 1 ()
Pages: 3-23

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Handle: RePEc:ijf:ijfiec:v:11:y:2006:i:1:p:3-23
DOI: 10.1002/ijfe.287
Contact details of provider: Web page: http://www.interscience.wiley.com/jpages/1076-9307/

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  1. Philippe Bacchetta & Eric van Wincoop, 2003. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," Working Papers 03.02, Swiss National Bank, Study Center Gerzensee.
  2. Charles Engel & Kenneth D. West, 2003. "Exchange rates and fundamentals," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  3. Martin D. D. Evans & Richard K. Lyons, 2007. "Exchange Rate Fundamentals and Order Flow," NBER Working Papers 13151, National Bureau of Economic Research, Inc.
  4. Martin D. D. Evans & Richard K. Lyons, 2005. "Meese-Rogoff Redux: Micro-Based Exchange-Rate Forecasting," American Economic Review, American Economic Association, vol. 95(2), pages 405-414, May.
  5. Hau, Harald & Rey, Hélène, 2003. "Exchange Rates, Equity Prices and Capital Flows," CEPR Discussion Papers 3735, C.E.P.R. Discussion Papers.
  6. 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 02-16, Duke University, Department of Economics.
  7. Evans, Martin D. D. & Lyons, Richard K., 2002. "Informational integration and FX trading," Journal of International Money and Finance, Elsevier, vol. 21(6), pages 807-831, November.
  8. Geir Høidal Bjønnes & Dagfinn Rime & Haakon O. Aa. Solheim, 2004. "Liquidity provision in the overnight foreign exchange market," Working Paper 2004/13, Norges Bank.
  9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  10. Rich Lyons & Martin Evans, 2004. "A New Micro Model of Exchange Rate Dynamics," Econometric Society 2004 North American Winter Meetings 622, Econometric Society.
  11. 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.
  12. Dunne, Peter & Hau, Harald & Moore, Michael, 2004. "Macroeconomic Order Flows: Explaining Equity and Exchange Rate Returns," CEPR Discussion Papers 4806, C.E.P.R. Discussion Papers.
  13. 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.
  14. 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.
  15. Martin D. D. Evans & Richard K. Lyons, 2003. "How is Macro News Transmitted to Exchange Rates?," NBER Working Papers 9433, National Bureau of Economic Research, Inc.
  16. Kenneth A. Froot & Tarun Ramadorai, 2002. "Currency Returns, Institutional Investor Flows, and Exchange Rate Fundamentals," NBER Working Papers 9101, National Bureau of Economic Research, Inc.
  17. 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.
  18. Rime,D., 2000. "Private or public information in foreign exchange markets? : an empirical analysis," Memorandum 14/2000, Oslo University, Department of Economics.
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