Structural Interdependence of Price and Demand in a Model of the Foreign Exchange Market with Heterogeneous Speculators: Evidence from High-frequency Data

Dipartimento di Scienze per l’Economia e l’Impresa Working Paper N. 04/2020

39 Pages Posted: 29 Apr 2020

See all articles by Leonardo Bargigli

Leonardo Bargigli

University of Florence - Department of Economics and Management

Giulio Cifarelli

DISEI University of Florence

Date Written: March 20, 2020

Abstract

We assume that the variations of the exchange rate depend on the current net demand of the base currency as a consequence of market making, and that the current net demand of the base currency depends on current and past variations of the exchange rate as a consequence of how future price expectations are formed by bounded rational agents. We achieve identification supposing that the structural shocks of price variations and demand follow a GARCH process. Using high-frequency transaction data of the EUR/USD market in 2016, we show that the simultaneous effects of price on demand and vice-versa are both significant and positive. Our estimates suggest that one important source of heterogeneity in demand might be missing from our model, since the structural errors are negatively correlated.

Keywords: Heterogeneous beliefs, market making, foreign exchange market, SVAR-GARCH, high frequency data

JEL Classification: G12, D84, F31, C32, C55

Suggested Citation

Bargigli, Leonardo and Cifarelli, Giulio, Structural Interdependence of Price and Demand in a Model of the Foreign Exchange Market with Heterogeneous Speculators: Evidence from High-frequency Data (March 20, 2020). Dipartimento di Scienze per l’Economia e l’Impresa Working Paper N. 04/2020, Available at SSRN: https://ssrn.com/abstract=3568786 or http://dx.doi.org/10.2139/ssrn.3568786

Leonardo Bargigli (Contact Author)

University of Florence - Department of Economics and Management ( email )

via delle Pandette 32
Florence, Florence 50127
Italy

Giulio Cifarelli

DISEI University of Florence ( email )

via delle Pandette 9
Florence 50127
Italy

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