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ORDER FLOW AND EXCHANGE RATE DYNAMICS: AN APPLICATION TO EMERGING MARKETS
Author(s) -
Duffuor Kwabena,
Marsh Ian W.,
Phylaktis Kate
Publication year - 2012
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.451
Subject(s) - market microstructure , exchange rate , emerging markets , market liquidity , order (exchange) , economics , monetary economics , foreign exchange , foreign exchange market , econometrics , financial economics , macroeconomics , finance
ABSTRACT The paper examines short‐run exchange rate dynamics in an emerging market based on the recent microstructure framework of foreign exchange markets where the main explanatory variable is the order flow of end‐user customers. The study makes two main contributions to the literature: it modifies the basic microstructural FX model to take account of key features of the majority of emerging markets, namely the existence of a black market for FX and the presence of market inefficiencies; and it uses a unique database covering almost the complete Ghanaian market, and for a long time span compared with previous studies. We find that the unexpected component of order flow has a positive and long‐lived effect on the official exchange rate in both stable and crisis periods, consistent with the basic microstructural approach. The price impact of unexpected order flow is related to the level of liquidity in the market. Expected order flow also impacts the exchange rate, suggesting inefficiencies in the market. Copyright © 2011 John Wiley & Sons, Ltd.