Market Microstructure Approach to the Exchange Rate Determination Puzzle (original) (raw)
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This article presents empirical test results of Malaysian foreign exchange market microstructure assessment of exchange rate dynamics. We apply vector autoregressive (VAR) model to estimate the influential role of currency order flow in the determination of the currency exchange rate for the Malaysian ringgit (MYR) against the US dollar (USD). We investigate whether currency order flow captures the movements of exchange rate of MYR against USD, and how the long-term and short-term components impact the relative estimation of MYR in the international market. We, construct a measure of order flow in the Malaysian foreign exchange market to reflect the pressure of currency excess demand. Our focus is on the cumulative currency order flow and the exchange rate relationship of MYR and USD. A hybrid model of order flow and exchange rate dynamics proposed by Evans and Lyons (2002a) is applied to the Malaysian foreign exchange market (MYR/USD) to analyse a dataset of every 15-minute currency order flow and exchange rate movements from January 2010 to December 2015. Our dataset has unique features in terms of the quality of the data, extensive period and precise high frequency. Our results show that currency order flow explains an important portion of the movements in the MYR–USD exchange rate. Keywords Exchange rate, currency order flow, market microstructure, foreign exchange market
International journal of management, economics & social sciences, 2020
Following the 2008 global financial crisis, the increased integration of economies has led to increased volatility and interdependence between the capital market and the exchange rate. Particularly, the free fall of oil price in the second half of 2014 spelt severe pressure and fluctuations on Nigeria's economic indicators with an attendant exchange rate crisis. In response, the all-share-index of the Nigerian Stock Exchange crashed by over 30 percent from 42,482.48 index points in June 2014 to 29,597.79 index points in the same period of 2016. Exchange rate is quite influential to the global business cycle and its movement reflects the competitiveness of a country in the international trade market (Ajayi and Mougoue, 1996; Alley, 2018; Dornbusch and Fischer, 1980). Not less can be said about the stock market for the speculative activities happening within it, which leads to uncertainty for market operators (Maku and Atanda, 2010; Tule, Dogo and Uzonwanne, 2018). Given the critical implications of fluctuations in these variables on each other and the economy, stability in both markets has become a great concern for academics and market players. Their continuous variation is generating unending
Exchange rate movement and stock market performance: An application of the ARDL model
Cogent Economics & Finance - Taylor & Francis Group, 2022
The study examines the relationship between the stock market and exchange rate in South Africa for the period from 1980 to 2020. Quarterly data was used employing the Autoregressive Distributed Lag (ARDL) model given the order of integration of the variables. The empirical results revealed that there is a long-term relationship between the variables of interest. The results also revealed that there is a negative relationship between the stock market and exchange rate movement. The results also show that there is a negative relationship between the stock market and the interest rate as well as inflation as measured by CPI. These results imply that innovations in the exchange rate do have an impact on what happens to the stock market. The impact of exchange rates on stock market can be positive in the short run and negative in the long run and so policymakers can use our findings to avoid making unnecessary monetary or fiscal policy decisions. Policy makers may be able to know when to intervene in influencing the markets using monetary or fiscal policies. Investors and portfolio managers can apply the findings of this study to hedge against exchange rate risk, efficiently diversify their portfolios and predict future stock market movements by observing the exchange rate market.
Order Flow and Exchange Rate Dynamics
Journal of Political Economy, 2002
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 naïve 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 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.
YOBE JOURNAL OF ECONOMICS, 2018
This paper presents the important role currency order flow plays in the foreign exchange markets of an economy that have undergone rapid financial market liberalization and mainly practiced managed-floating exchange rate regime. We focused on two main objectives. First, the role of currency order flow in determining exchange rate movements and second, the short-run and long-run interaction between micro-macroeconomic variables and exchange rate. A portfolio shift model is applied to analyze a dataset of every fifteen-minute currency order flow and exchange rate movements of Singapore dollar (SGD) against the US dollar (USD) over a 6-year period (2010-2015). VAR model, VECM and FEVD are used to determine the interaction between micro-macroeconomic variables and exchange rates. The findings show that exchange rates at short horizons are driven by currency order flow. Likewise, currency order flow appears to be the only influential determinant of exchange rate of SGD against the USD. This paper therefore, sheds more light to Monetary Authority of Singapore, market dealers and market players on the importance of market microstructure in the foreign exchange markets.
Modeling the Exchange rate long-range dependence of some world emerging markets
2017
This research examined over ten years Chinese Yuan (CNY), Indian Rupees (INR), Nigerian Naira (NGN) and Malaysia Ringgits (MYR) daily to the U.S Dollar exchange rate using the conditional mean models namely: the Autoregressive Integrated Moving Average (ARIMA) and the Autoregressive Fractional Integrated Moving Average (ARFIMA) models. The best candidate modelswere selected using Akaike Information Criteria (AIC). Approaches used for testing and estimating long memory parameters are the rescaled range tests [1-3] and Local Whittle Estimator developed by Robinson [4]. The white noise, serial correlation and the heteroscedasticity test was carried out. Unit roots tests confirmed the nonstationary of all the four series while the inconsistency results obtained from the long memory parameters estimates guided the use of two modeling approaches. The findings revealed that the ARIMA model is the best to study CNY, INR and MYR to the U.S Dollar exchange rate while ARFIMA method is the suit...
Foreign exchange trading models and market behavior
Journal of Economic Dynamics and Control, 2003
The contributions of this paper are twofold. First, the performance of a widely used commercial real-time trading model is compared with a simple exponential moving average model. Second, the trading models are used as diagnostic tools to evaluate the statistical properties of foreign exchange rates.
Exchange rates and fundamentals: Co-movement, long-run relationships and short-run dynamics
Journal of Banking & Finance, 2014
The present study builds upon the seminal work of Engel and West [2005, Journal of Political Economy 113, 485-517] and in particular on the relationship between exchange rates and fundamentals. The paper discusses the well-known puzzle that fundamental variables such as money supplies, interest rates, outputs etc. provide help in predicting changes in floating exchange rates. It also tests the theoretical result of that in a rational expectations present-value model, the asset price manifests near-random walk behaviour if the fundamentals are I(1) and the factor for discounting future fundamentals is near one. The study explores the direction and nature of causal interdependencies and cross-correlations among the most widely traded currencies in the world, their country-specific fundamentals and their US-differentials. A new VAR/VECM-GARCH multivariate filtering approach is implemented, whilst linear and nonlinear non-causality is tested on the time series. In addition to pairwise causality testing, several different groupings of variables are explored. The methodology is extensively tested and validated on simulated and empirical data. The implication is that although exchange rates and fundamentals appear to be linked in a way that is broadly consistent with asset-pricing models, there is no indication of a prevailing causal behaviour from fundamentals to exchange rates or vice-versa. When nonlinear effects are accounted for, the evidence implies that the pattern of leads and lags changes over time. These results may influence the greater predictability of currency markets. Overall, fundamentals may be important determinants of FX rates, however there may be some other unobservable variables driving the currency rates that current assetpricing models have not yet captured.
Applied Financial Economics, 1996
It is demonstrated how the techniques of unit root testing and cointegration may be used to test for common stochastic trends, and their implications for addressing the market e ciency hypothesis (MEH) in a multivariate context within a seven-variable system of major daily (unpublished) spot exchange rates of the Malaysian ringgit. Finding the evidence of two cointegrating vectors, a vector error-correction model is developed to test for the direction of temporal causal dynamics (in the Granger sense) within this system before investigating the relative strength of the causality by decomposing the total impact of an unanticipated shock to each of the variables beyond the sample period, into proportions attributable to shocks in the other variables including its own. Results from the analysis tend to suggest a violation of the MEH in a speculative sense, due to the presence of two cointegrating vectors which also withstood the temporal instability test. The VECM and decompositions of forecast error variances consistently point to the relative exogeneity of the British pound sterling and Swiss franc, whereas for all other spot rates, at least one channel of causality was temporally active. In other words, the dynamic interactions tend broadly to indicate that the British sterling and Swiss franc were the initial receptors of exogenous shocks to their equilibrium relationships. All other rates within this system had to bear the burden of short-run adjustment to re-establish the long-run equilibrium. Moreover, the analysis of variance decompositions brings to light the vital role played by both the Japanese yen and US dollar in the international ® nancial market in terms of their relative in¯uence on both the Asian markets (such as Hong Kong and Singapore) and the European market (such as Germany); that the British sterling and Swiss franc play relatively the most exogenous role remains largely unexplained.