Fixed versus Flexible: Lessons from EMS Order Flow

William P. Killeen, Richard Lyons () and Michael Moore

No 8491, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper addresses the puzzle of regime-dependent volatility in foreign exchange. We extend the literature in two ways. First, our microstructural model provides a qualitatively new explanation for the puzzle. Second, we test implications of our model using Europe's recent shift to rigidly fixed rates (EMS to EMU). In the model, shocks to order flow induce volatility under flexible rates because they have portfolio-balance effects on price, whereas under fixed rates the same shocks do not have portfolio-balance effects. These effects arise in one regime and not the other because the elasticity of speculative demand for foreign exchange is (endogenously) regime-dependent: low elasticity under flexible rates magnifies portfolio-balance effects; under credibly fixed rates, elasticity of speculative demand is infinite, eliminating portfolio-balance effects. New data on FF/DM transactions show that order flow had persistent effects on the exchange rate before EMU parities were announced. After announcement, determination of the FF/DM rate was decoupled from order flow, as predicted by the model.

JEL-codes: F31 G12 (search for similar items in EconPapers)
Date: 2001-09
New Economics Papers: this item is included in nep-eec and nep-ifn
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (28)

Published as Killeen, William P., Richard K. Lyons and Michael J. Moore. "Fixed Versus Flexible: Lessons From EMS Order Flow," Journal of International Money and Finance, 2006, v25(4,Jun), 551-579.

Downloads: (external link)
http://www.nber.org/papers/w8491.pdf (application/pdf)

Related works:
Journal Article: Fixed versus flexible: Lessons from EMS order flow (2006)
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:nbr:nberwo:8491

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w8491

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().