Order Flow in the South: Anatomy of the Brazilian FX Market

Abstract

Using a unique dataset that covers 100% of the Brazilian FX retail market, this paper contributes to the microstructure approach to exchange rates in at least four ways. First, we find a strict link between currency flows in the FX market and the Balance of Payments. Second, we develop an identification strategy in order to properly estimate the effect of customer order flows on the exchange rate and find that dealers from the Brazilian FX market charge a premium of 0.03% in order to provide US$ 10 million overnight liquidity. Third, we identify the nature of the feedback trading as "stabilizing": a 1% depreciation rate decreases the financial customer flow by US$ 111 million and the commercial flow by US$ 46 million. Finally, we find that the central bank sells in average US$ 28 million for each 1% depreciation in the exchange rate (lean-against-the-wind), and US$ 23 million for US$ 100 million of financial customer flow (liquidity provision).