Exchange rate forecasting, order flow and macroeconomic information |
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Authors: | Dagfinn Rime Lucio Sarno Elvira Sojli |
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Affiliation: | a Norges Bank, Research Department, Norges Bank, P.O. Box 1179 Sentrum, 0107 Oslo, Norway b Norwegian University of Science and Technology, Norway c Faculty of Finance, Cass Business School, City University, 106 Bunhill Row, London EC1Y 8TZ, UK d Centre for Economic Policy Research (CEPR), UK e Rotterdam School of Management, Erasmus University, Department of Finance, Room T9-31, Burgemeester Oudlaan 50, P.O. Box 1738, 3000 DR, Rotterdam, The Netherlands |
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Abstract: | This paper adds to the research efforts that aim to bridge the divide between macro and micro approaches to exchange rate economics by examining the linkages between exchange rate movements, order flow and expectations of macroeconomic variables. The basic hypothesis tested is that if order flow reflects heterogeneous expectations about macroeconomic fundamentals, and currency markets learn about the state of the economy gradually, then order flow can have both explanatory and forecasting power for exchange rates. Using one year of high frequency data collected via a live feed from Reuters for three major exchange rates, we find that: i) order flow is intimately related to a broad set of current and expected macroeconomic fundamentals; ii) more importantly, order flow is a powerful predictor of daily movements in exchange rates in an out-of-sample exercise, on the basis of economic value criteria such as Sharpe ratios and performance fees implied by utility calculations. |
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Keywords: | F31 F41 G10 |
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