Exchange rate determination and inter-market order flow effects

Jon Danielsson, Jinhui Luo and Richard Payne ()

The European Journal of Finance, 2012, vol. 18, issue 9, 823-840

Abstract: The dependence of foreign exchange rates on order flow is investigated for four major exchange rate pairs, EUR/USD, EUR/GBP, GBP/USD and USD/JPY, across sampling frequencies ranging from 5 min to 1 week. Strong explanatory power is discovered for all sampling frequencies. We also uncover cross-market order flow effects, e.g. GBP exchange rates are very strongly influenced by EUR/USD order flow. We proceed to investigate the predictive power of order flow for exchange rate changes, and it is shown that the order flow specifications reduce RMSEs relative to a random walk for all exchange rates at high-frequencies and for EUR/USD and USD/JPY at lower sampling frequencies.

Date: 2012
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DOI: 10.1080/1351847X.2011.601655

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