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The Market Microstructure Approach to Foreign Exchange: Looking Back and Looking Forward

  • Michael King

    ()

    (Ivey Business School, University of Western Ontario)

  • Carol Osler

    ()

    (International Business School, Brandeis University)

  • Dagfinn Rime

    (Norges Bank)

Looking back, 30 years of research on foreign exchange (FX) market microstructure reveals that order flow, heterogeneity among agents, and private information are crucial determinants of short-run exchange rate dynamics. Microstructure researchers have produced empirically-driven models that fit the data surprisingly well. But currency markets are evolving rapidly in response to new electronic trading technologies. Transparency has risen, trading costs have tumbled, and transaction speed has accelerated as new players have entered the market and existing players have modified their behavior. These changes will have profound effects on exchange rate dynamics. Looking forward, we highlight fundamental yet unanswered questions on the nature of private information, the impact on market liquidity, and the changing process of price discovery. We also outline potential microstructure explanations for long-standing exchange rate puzzles.

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Paper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 54.

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Length: 40 pages
Date of creation: Oct 2012
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