Order Flow and Exchange Rate Dynamics
Macroeconomic models of nominal exchange rates perform poorly. In sample, R2 statistics as high as 10 percent are rare. Out of sample, these models are typically out-forecast by a naÃ¯ve random walk. This paper presents a model of a new kind. Instead of relying exclusively on macroeconomic determinants, the model includes a determinant from the field of microstructure--order flow. Order flow is the proximate determinant of price in all microstructure models. This is a radically different approach to exchange rate determination. It is also strikingly successful in accounting for realized rates. Our model of daily exchange-rate changes produces R2 statistics above 50 percent. Out of sample, our model produces significantly better short-horizon forecasts than a random walk. For the DM/$ spot market as a whole, we find that $1 billion of net dollar purchases increases the DM price of a dollar by about 0.5 percent.
|Date of creation:||11 Jan 2001|
|Contact details of provider:|| Postal: Georgetown University Department of Economics Washington, DC 20057-1036|
Web page: http://econ.georgetown.edu/
|Order Information:|| Postal: Roger Lagunoff Professor of Economics Georgetown University Department of Economics Washington, DC 20057-1036|
Web: http://econ.georgetown.edu/ Email:
When requesting a correction, please mention this item's handle: RePEc:geo:guwopa:gueconwpa~01-01-12. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marcia Suss)
If references are entirely missing, you can add them using this form.