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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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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
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  1. Charles Engel & Kenneth D. West, 2003. "Exchange rates and fundamentals," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  2. 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.
  3. Rime,D., 2000. "Private or public information in foreign exchange markets? : an empirical analysis," Memorandum 14/2000, Oslo University, Department of Economics.
  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. Harald Hau & Hélène Rey, 2006. "Exchange Rates, Equity Prices, and Capital Flows," Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 273-317.
  6. 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.
  7. 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.
  8. Martin Evans and Richard K. Lyons, 2002. "Informational Integration and FX Trading," Working Papers gueconwpa~02-02-11, Georgetown University, Department of Economics.
  9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  10. 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.
  11. Rich Lyons & Martin Evans, 2004. "A New Micro Model of Exchange Rate Dynamics," Econometric Society 2004 North American Winter Meetings 622, Econometric Society.
  12. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange?," Center for Financial Institutions Working Papers 02-23, Wharton School Center for Financial Institutions, University of Pennsylvania.
  13. 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.
  14. 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.
  15. Evans, Martin D.D. & Lyons, Richard K., 2008. "How is macro news transmitted to exchange rates?," Journal of Financial Economics, Elsevier, vol. 88(1), pages 26-50, April.
  16. 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.
  17. 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.
  18. Martin D. D. Evans & Richard K. Lyons, 2007. "Exchange Rate Fundamentals and Order Flow," NBER Working Papers 13151, National Bureau of Economic Research, Inc.
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