Dealer information and macro fundamentals - New evidence from hybrid exchange rate models

49 Pages Posted: 31 Jan 2019

See all articles by Ingomar Krohn

Ingomar Krohn

University of Warwick - Finance Group

Michael Moore

University of Warwick - Warwick Business School

Date Written: May 23, 2017

Abstract

We construct a new class of hybrid exchange rate models, combining macroeconomic fundamentals from a conventional Taylor rule with information from the foreign exchange interdealer market. We provide evidence that hybrid models have a superior model fit and produce more accurate in-sample predictions than their individual nested components. As part of our analysis, we employ a new market microstructure measure, based on submitted and cancelled limit orders, and document its significant impact on monthly exchange rate returns. We show that its effect is transitory and largely diminishes in a stylized out-of-sample forecasting exercise, while market order flow can improve short-term forecasts. Our comprehensive empirical assessment is based on one of the largest foreign exchange interdealer data sets analysed so far. It comprises nineteen U.S. dollar and euro currency pairs and covers a sample period of more than ten years.

Keywords: exchange rates, Taylor rule, order flow, microstructure

JEL Classification: D82, E52, F31

Suggested Citation

Krohn, Ingomar and Moore, Michael John, Dealer information and macro fundamentals - New evidence from hybrid exchange rate models (May 23, 2017). WBS Finance Group Research Paper No. 2975006. Available at SSRN: https://ssrn.com/abstract=2975006 or http://dx.doi.org/10.2139/ssrn.2975006

Ingomar Krohn (Contact Author)

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

Michael John Moore

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

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