Order Flows and The Exchange Rate Disconnect Puzzle

Working Papers from Georgetown University, Department of Economics

Abstract: The aim of this paper is to establish the link between the high frequency dynamics of spot exchange rates and developments in the macroeconomy. To do so, I first present a theoretical model of exchange-rate determination that bridges the gap between existing microstructure and traditional models. I then report empirical evidence that strongly supports the presence of the link between the macroeconomy, order flow and high frequency exchange rate returns implied by the model. In fact, my empirical results indicate that between 20 and 30 percent of the variance in excess currency returns over one- and two-month horizons can be linked back to developments in the macroeconomy. This level of explanatory power is an order of magnitude higher than that found in traditional models even the newly developed monetary models incorporating central banks reaction functions. Moreover, it provides a straightforward solution to the exchange-rate disconnect puzzle. Namely, the high frequency behavior of spot exchange rates reflects the flow of new information reaching dealers concerning the slowly evolving state of the macroeconomy, rather than the effects of shocks that drive rapidly changing macroeconomic conditions.

Keywords: Exchange Rate Dynamics; The Exchange Rate Disconnect Puzzle; Microstructure; Order Flow. (search for similar items in EconPapers)
JEL-codes: F3 F4 G1 (search for similar items in EconPapers)
Date: 2008-08-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://www8.georgetown.edu/departments/economics/pdf/805.pdf Full text (application/pdf)
None

Related works:
Chapter: Order Flows and the Exchange Rate Disconnect Puzzle (2017)
Journal Article: Order flows and the exchange rate disconnect puzzle (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:geo:guwopa:gueconwpa~08-08-05

Ordering information: This working paper can be ordered from
Roger Lagunoff Professor of Economics Georgetown University Department of Economics Washington, DC 20057-1036
http://econ.georgetown.edu/

Access Statistics for this paper

More papers in Working Papers from Georgetown University, Department of Economics Georgetown University Department of Economics Washington, DC 20057-1036.
Bibliographic data for series maintained by Marcia Suss ( this e-mail address is bad, please contact ).