Market Microstructure Approach to the Exchange Rate Determination Puzzle

The IUP Journal of Monetary Economics, Vol. VII, Nos. 3 & 4, pp. 101-115, August & November 2009

Posted: 26 Aug 2009

See all articles by Thabo Mokoena

Thabo Mokoena

affiliation not provided to SSRN

Rangan Gupta

University of Pretoria - Department of Economics

Renee Koekemoer Van Eyden

University of Pretoria

Date Written: August 25, 2009

Abstract

Market microstructure approach claims that the imbalances between ‘buyer-initiated and seller-initiated trades’ in foreign exchange markets are indicative of the transmission link between exchange rates and fundamental determinants of exchange rates. In the context of the exchange rate determination puzzle, this paper uses Autoregressive Distributed Lag (ARDL) model to discuss the market microstructure approach from the standpoint of hybrid models that integrate order flow, fundamentals and non-fundamental variables to establish the determinants of the rand-dollar exchange rate. Among the non-fundamentals considered are the Economist’s commodity price index, and a proxy for country risk - the differential between the Global Emerging Market Bond Index and the South African long-term bond. The results, based on the Schwarz Bayesian Criterion, used for choosing a model’s lag length, show that there is a long-run relationship between the rand-dollar real exchange rate, non-fundamentals, fundamentals and the proxy for order flow, which is the dollar-denominated daily net turnover in the South African markets.

Suggested Citation

Mokoena, Thabo and Gupta, Rangan and Koekemoer Van Eyden, Renee, Market Microstructure Approach to the Exchange Rate Determination Puzzle (August 25, 2009). The IUP Journal of Monetary Economics, Vol. VII, Nos. 3 & 4, pp. 101-115, August & November 2009, Available at SSRN: https://ssrn.com/abstract=1461321

Thabo Mokoena (Contact Author)

affiliation not provided to SSRN ( email )

Rangan Gupta

University of Pretoria - Department of Economics ( email )

Lynnwood Road
Hillcrest
Pretoria, 0002
South Africa

Renee Koekemoer Van Eyden

University of Pretoria ( email )

Physical Address Economic and Management Sciences
Pretoria, Gauteng 0002
South Africa

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