Portfolio Reallocation and Exchange Rate Dynamics

This paper provides a market-microstructure analysis of exchange rate dynamics in the Chinese foreign exchange market using a vector autoregressive (VAR) modeling framework. An index of order flow is constructed in the Chinese context to reflect excess demand pressure in the foreign exchange market. The VAR model is then estimated to examine whether, and to what extent, order flow influences the long-term level and short-term fluctuations of the Chinese exchange rate. Focusing on the relationship between cumulative order flow and the exchange rate of the Chinese renminbi (RMB) against the US dollar, we find that order flow as a measure of excess demand pressure explains a significant part of the fluctuations in the RMB–dollar exchange rate. Specifically, the results show that there is a long-term cointegrating relationship among the order flow, macro factors and the exchange rate. Overall, these findings are important in understanding the role of order flow in exchange rate determination and bear important implications for practitioners and market regulators.

Macroeconomic models of nominal exchange rates perform poorly. In sample, R 2 statistics as high as 10 percent are rare. Out of sample, these models are typically out-forecast by a nave 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 exchangerate changes produces R 2 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 1 pfennig.

The Dynamic Interaction of Order Flows and the CAD/USD Exchange Rate

Order flow and central bank intervention: An empirical analysis of recent Bank of Japan actions in the foreign exchange market

This paper empirically investigates the Evans and Lyons’ [2002. Understanding order flow. International Journal of Finance and Economics 11: 3–23] model of the foreign exchange market from a dealer's perspective. We provide evidence of the suggested information aggregation process using a rich database on a German bank's end-user order flow from 2002 to 2003. Although customer order flow is unambiguously the vehicle incorporating non-public information into exchange rates over time, our empirical analysis does not support the idea that customer order flow is a high-powered source of information easily exploitable for short-run speculation.

Are exchange rates absorbers of global oil shocks? A generalized structural analysis

Order Flow and Exchange Rate Dynamics in Brazil

An Entropic Dynamics of exchange rates is laid down to model the dynamics of foreign exchange rates, FX, and European Options on FX. The main objective is to represent an alternative framework to model dynamics. Entropic inference is an inductive inference framework equipped with proper tools to handle situations where incomplete information is available. Entropic Dynamics is an application of entropic inference, which is equipped with the entropic notion of time to model dynamics. The scale invariance is a symmetry of the dynamics of exchange rates, which is manifested in our formalism. To make the formalism manifestly invariant under this symmetry, we arrive at choosing the logarithm of the exchange rate as the proper variable to model. By taking into account the relevant information about the exchange rates, we derive the Geometric Brownian Motion, GBM, of the exchange rate, which is manifestly invariant under the scale transformation. Securities should be valued such that there is no arbitrage opportunity. To this end, we derive a risk-neutral measure to value European Options on FX. The resulting model is the celebrated Garman–Kohlhagen model.

A comparative study of exchange rates and order flow based on wavelet transform coherence and cross wavelet transform

This paper investigates whether customer order flow conveys information about future foreign exchange (FX) prices. We use a unique data set from a leading Australian commercial bank that records every FX trade made by the bank in the spot Australian dollar/US dollar market between 2005 and 2010. We find little evidence in support of a cointegrating relation or a statistically significant correlation between customer order flow and FX returns. However, consistent with the liquidity provision role of non-financial customers in Evans and Lyons ((2002) Order flow and exchange rate dynamics. Journal of Political Economy 110: 170–180), we find a statistically significant negative correlation between order flow from the diversified economic sector and FX returns. A dynamic analysis suggests that order flow has little or no price impact on FX returns. These results suggest that the non-financial customer order flow of a commercial bank does not carry information about FX prices.

The recent rapidly growing literature on rate (which for the most part, has stemmed from Dornbusch's [5] seminal contribution) can be roughly divided into two main categories. One category emphasizes the asset-market view of exchange rate determination, wherein the instantaneous exchange rate is determined by the condition of continuous financial market equilibrium, its dynamics being governed by slowly evolving prices. This is the view taken, for example in the original contribution of Dornbusch [5] as well as in Mathieson [10], Bilson [2], Witte [16], and Dornbusch [7]. An alternative approach to exchange rate determination and dynamics may be termed the approach. This approach is primarily concerned with imperfect substitutability between domestic and foreign assets. The spot exchange rate is determined by the requirement of balance between actual and desired portfolio compositions. Differential speeds of adjustment between asset and goods markets are not stressed in this approach; instead exchange rate (and other) dynamics result from wealth accumulation, which in turn, are due to accumulated current account imbalances. Chief among the contributions along this line of inquiry have been Kouri [4], Branson [3], Dornbusch and Fischer [6] and to some extent Rodriguez [12] and Dooley and Isard [4]. A comparison and synthesis of these two approaches is attempted in Henderson [8]. An assumption that is universally employed by the above authors is the assumption. Specifically, the country under question is small in commodity import markets (but not in export markets) as well as in the security market, to the extent that the world price of importables as well as the world yield on international securities are parametrically given. Such a setting might indeed be appropriate for describing certain situations (for example, the international economic relations between Denmark and the U.S.) but is completely inapplicable as a framework characterizing trade (in goods and securities) between countries of roughly equal economic size (such as France and Germany). The major proportion of international trade in any European country is conducted with other European coun-

The Flows of the Pacific: Asian Foreign Exchange Markets through Tranquility and Turbulence

Monetary and Fiscal Policy Under Nonlinear Exchange Rate Dynamics

PurposeThe main aim of this paper is to examine the mechanism of determining the exchange rate of the US dollar against the Indonesian rupiah (USD/IDR) by market players to manage the USD/IDR exchange rate stability. Thus, this study is expected to provide a better understanding of the determinants of the USD/IDR, given that the data set completely encompasses all the USD/IDR transactions in the Indonesian foreign exchange market. Order flow data used in this study cover all transactions on the USD/IDR conducted by domestic residents including both individuals and corporations and foreign investors in the Indonesian foreign exchange market.Design/methodology/approachThis study covers the data set over the period January 3, 2011 to December 31, 2015, and the vector autoregression and autoregressive distributed lag models are used in examining the research questions. More particularly, in this study, the author examines whether the net total domestic individual transactions (DOVA), net total domestic corporation transactions (KOVA), net total foreign investor transactions (IOVA), Asian Dollar Index (ADXY), non-deliverable forward (NDF) for USD/IDR and Volatility Index (VIX) are statistically significant determinants of the USD/IDR exchange rate.FindingsOverall, this study suggests that in the short run, lag of the USD/IDR exchange rate or inertia level, lag of the IOVA, lag of the NDF of the USD/IDR exchange rate and lag of the ADXY are statistically significant determinants of the USD/IDR. On the other hand, in the long run, DOVA, NDF and ADXY are found to be statistically significant determinants of USD/IDR. This study also found that there is a market leader and asymmetric information among market players in the Indonesian foreign exchange market, and their USD/IDR exchange rate level becomes a reference for other market players when conducting transactions with each other.Originality/valueThe paper is original along two lines. First, the data set used in this study is unique. It encompasses all the USD/IDR transactions in the Indonesian foreign exchange market. The order flow data used in this study cover all transactions on the USD/IDR conducted by domestic residents (includes both individuals and corporations) and foreign investors in the Indonesian foreign exchange market. Such an approach has not been used previously to study the exchange rate behavior in an emerging market. Second, there is limited knowledge on Indonesia’s exchange rate dynamics. This study fills this gap.

Customer Order Flow and Exchange Rate Movements: Is there Really Information Content?