An Empirical Study of Liquidity and Information Effects of Order Flow on Exchange Rates

Breedon, Francis; Vitale, Paolo

doi:10.2139/ssrn.631671

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An Empirical Study of Liquidity and Information Effects of Order Flow on Exchange Rates

45 Pages Posted: 10 Jan 2005

See all articles by Francis Breedon

Francis Breedon

University of London, Queen Mary - School of Economics and Finance

Paolo Vitale

G. d'Annunzio University - Dipartimento di Economia

There are 2 versions of this paper

Date Written: December 2004

Abstract

We propose a simple structural model of exchange rate determination which draws from the analytical framework recently proposed by Bacchetta and van Wincoop (2003) and allows us to disentangle the liquidity and information effects of order flow on exchange rates. We estimate this model employing an innovative transaction data-set that covers all direct foreign exchange transactions completed in the USD/EUR market via EBS and Reuters between August 2000 and January 2001. Our results indicate that the strong contemporaneous correlation between order flow and exchange rates is mostly due to liquidity effects. This result also appears to carry through to the four FX intervention events that appear in our sample.

Keywords: Order Flow, Foreign Exchange Micro Structure, Exchange Rate Dynamics

JEL Classification: D82, G14, G15

Suggested Citation: Suggested Citation

Breedon, Francis and Vitale, Paolo, An Empirical Study of Liquidity and Information Effects of Order Flow on Exchange Rates (December 2004). Available at SSRN: https://ssrn.com/abstract=631671 or http://dx.doi.org/10.2139/ssrn.631671