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Structural Interdependence of Price and Demand in a Model of the Foreign Exchange Market with Heterogeneous Speculators: Evidence from High-frequency Data

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  • Leonardo BARGIGLI
  • Giulio CIFARELLI

Abstract

We assume that the variations of the exchange rate depend on the current net demand of the base currency as a consequence of market making, and that the current net demand of the base currency depends on current and past variations of the exchange rate as a consequence of how future price expectations are formed by bounded rational agents. We achieve identification supposing that the structural shocks of price variations and demand follow a GARCH process. Using high-frequency transaction data of the EUR/USD market in 2016, we show that the simultaneous effects of price on demand and viceversa are both significant and positive. Our estimates suggest that one important source of heterogeneity in demand might be missing from our model, since the structural errors are negatively correlated.

Suggested Citation

  • Leonardo BARGIGLI & Giulio CIFARELLI, 2020. "Structural Interdependence of Price and Demand in a Model of the Foreign Exchange Market with Heterogeneous Speculators: Evidence from High-frequency Data," Working Papers - Economics wp2020_04.rdf, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
    • Handle: RePEc:frz:wpaper:wp2020_04.rdf
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    More about this item

    Keywords

    Asset pricing model; heterogeneous beliefs; market making; foreign exchange market; SVAR-GARCH; high frequency data.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis

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