EXPLAINING EXCHANGE RATE MOVEMENTS: AN APPLICATION OF THE MARKET

MICROSTRUCTURE APPROACH ON THE PAKISTANI FOREIGN EXCHANGE MARKET

Author(s): Abdul Jalil and Mete Feridun
Source: The Journal of Developing Areas, Vol. 44, No. 1 (Fall 2010), pp. 255-265
Published by: College of Business, Tennessee State University
Stable URL: http://www.jstor.org/stable/41428204
Accessed: 07-05-2016 14:22 UTC

REFERENCES
Linked references are available on JSTOR for this article:
http://www.jstor.org/stable/41428204?seq=1&cid=pdf-reference#references_tab_contents
You may need to log in to JSTOR to access the linked references.

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
http://about.jstor.org/terms

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted
digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about
JSTOR, please contact support@jstor.org.

College of Business, Tennessee State University is collaborating with JSTOR to digitize, preserve and
extend access to The Journal of Developing Areas

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 EXPLAINING EXCHANGE RATE
MOVEMENTS: AN APPLICATION OF THE
MARKET MICROSTRUCTURE APPROACH ON
THE PAKISTANI FOREIGN EXCHANGE
MARKET

Abdul Jalil1*
Wuhan University, China
Mete Feridun
Eastern Mediterranean University, Turkey

ABSTRACT

This present article aims at explaining the exchange rate movements in the Pakistani foreign
exchange market using the market micro structure approach, which has not been applied to date due
to the unavailability of high-frequency data on the order flow for Pakistan. The novelty of the
present article is that it uses publicly unavailable micro data obtained from the State Bank of
Pakistan and that it employs ARCH/GARCH regression methods in addition to the OLS technique
suggested by the existing literature. Strong evidence emerged suggesting that order flow is a key
variable that explains the movements in exchange rate over a short term in the case of Pakistan.

JEL Classification: F31 G14

Key Words: market microstructure, Order flow, Pakistan
Corresponding Author's Email Address: mete.feridun@gmail.com

INTRODUCTION

The market microstructure theory focuses on the behavior of market agents and market
characteristics rather than the influence of macroeconomic relations such as money
demand, purchasing-power parity and relative prices. Hence it is concerned with the
micro aspects of the foreign exchange market, such as the transmission of information
among market participants, the behavior of market agents, the importance of order flow,
the heterogeneity of agents expectations, and the implication of such heterogeneity for
trading volume and exchange rate volatility.
Evans and Lyons (2002) delivered a breakthrough in the emerging literature on
market microstructure by proposing that the time aggregated order flow variables
measured as the net of demand initiated deals and supply initiated deals, have more
powerful explanatory power than the macro economic variables. The authors considered
a very simple model of exchange rate determination which makes use of the information
contained in order flow. According to this model daily exchange rate variations are
determined by changes in the interest rate differential, as suggested by traditional models,

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 256

as well as order flow. Intuitively, if the demand initiated deals are higher than the supply
initiated deals then the exchange rate depreciates. Evans and Lyons (2002) empirically
documented the positive relationship between order flow and currency depreciation.
The more recent literature on market microstructure theory suggests mixed
evidence on the impact of macro news on currency prices directly and indirectly via order
flow. For instance, Boyer and van Norden (2006) investigated microstructure effects in
understanding exchange rate behavior by analyzing the long-run relationships between
cumulated order flows and spot exchange rates and found that such relationship does
exist, albeit for a small number of the major currencies. Investigating the roles of order
flow and news in explaining exchange rate volatility, Frommel et al (2007) used three
different kinds of order flow in an analysis of a bank's high frequency U.S. dollar/euro
trading. The authors reported empirical evidence that only larger sized order flows from
financial customers and banks contribute to explaining volatility, whereas flows from
commercial customers do not. Gradojevic (2007) investigated the performance robustness
of the pure microstructure Canada/U.S. dollar exchange rate model and found that, when
used for forecasting, this microstructure model is very sensitive to the choice of time
period and forecasting horizon. On the other hand, using a unique high-frequency futures
dataset, Andersen et al (2007) investigated the response of U.S., German and British
exchange markets to real-time U.S. macroeconomic news. The authors obtained strong
evidence that exchange rate dynamics are linked to fundamentals. In a more recent study,
Evans and Lyons (2008) found empirical evidence that the arrival of macro news can
account for more than one-third of daily price variance. The authors also obtained
evidence that order flow variations contribute more to currency price dynamics following
the arrival of public macro news than at other times and that roughly two -thirds of the
total effect of macro news on the Deutsche Marl/ U.S. dollar exchange rate is transmitted
via order flow. In another recent study, Love and Payne (2008) quantified the role that
order flow plays and found that approximately one third of price -relevant information is
incorporated via the trading process. Using transaction level exchange rate return and
trading data and a sample of scheduled macroeconomic announcements, the authors
obtained evidence that even information that is publicly and simultaneously released to
all market participants is partially impounded into prices via order flow.
A core distinction between a microstructure approach to exchange rates and the
traditional macroeconomic approach is the role of trades and traders in price
determination. In macro models, trades and traders have no distinct role in determining
price. In microstructure models, traders have a leading role that is they are the proximate
cause of price adjustment. The purpose of this article is to explain the exchange rate
movements, based on the Evans and Lyons model (2002) in the Pakistani foreign
exchange market. In the broad literature on the emerging market economies, Pakistan has
widely been neglected. In fact, Pakistan is an interesting case. Pakistan, like many of the
other developing economies, continued with the fixed exchange rate regime until 1982
when it shifted to managed float. Staring from July 2000, on the other hand, the Pakistani
policy-makers switched to a free float, where inter-bank market was supposed to make
the foreign exchange payments and received the foreign exchange receipts without the
intervention of State Bank of Pakistan (SBP), which, in turn, led the rupee US dollar
parity to depict a great deal of volatility. The management of foreign exchange market
was indeed not an easy task; especially, when the foreign exchange market was thin and

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 257

dominated by a relatively small number of agents. The SBP started intervening in the
foreign exchange market to moderate the exchange rate fluctuations by both managing
the mismatch between US dollar demand and supply and by quelling the speculative
moves of a few agents. Therefore, it would be interesting to analyze, in a scenario when
inter-bank market and SBP both were the players, the extent to which market itself has
been successful to set the exchange rate and the extent SBP has been successful in its
objective of smoothing exchange rate fluctuations through intervention.
The order flows, net open position (NOP) in our case, in the foreign exchange
market to determine and stabilize exchange rate can be divided into two distinct episodes
as can be seen in Figure 1 .

FIGURE 1. EXCHNAGE RATE, NOP AND FOREIGN EXCHANGE

INTERVENTIONS

In the first episode, from September 2001 to March 2004, the dollar supply
exceeded the dollar demand. The inter-bank market was inclined to selling in both spot
and forward market as the exchange rate was appreciating. As a result SBP purchased
surplus dollar from the market to moderate the abrupt appreciation in the rupee and to
protect the export competitiveness. But, in start of 2004, the pre-payment of costly debt
policy and the lower inflows from exports receipts and heavy outflows of imports
payments intensified payment pressures on inter-bank market; the aggregate NOP of
banks rose significantly, reaching negative US$ 100 million by April 2004. Thus, in order
to maintain Rupee Dollar parity, SBP re-profiled its foreign exchange market operations,
providing foreign exchange liquidity through net sales to the market since April 2004.
Since April 2004, SBP is selling dollars to support the rupee in the deteriorating external
account scenario in the second episode. Moreover, SBP announced to make oil and other
lumpy payments from its reserves with effect from November 1, 2004 to quell the

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 258

speculative pressure on the exchange rate. The graphical analysis suggests that, in these
two episodes, order flows and foreign exchange intervention has clear effects in
smoothing the exchange rate fluctuations. To this end, we apply the market micro
structure approach, which has not been applied to date due to the unavailability of high-
frequency data on the order flow for Pakistan. The purpose of the present study is,
therefore to fill this gap in the literature. The novelty of the present article is that it uses
publicly unavailable micro data obtained from the treasury of State Bank of Pakistan.
Besides, a novel variable, net open position as suggested by (Canales-Krilijenko 2003) to
proxy the order flow in the Pakistani foreign exchange market. Another novelty of the
present analysis is that it employs ARCH/GARCH regression methods in addition to the
OLS technique suggested by the earlier studies in the literature (see Evans and Lyons,
2002) to explain the exchange rate movements in Pakistan.
The rest of the article is organized as follows. Section II will introduce the data
and the methodology. Section III will present the empirical results and the final section
will conclude the paper.

DATA AND METHODLOGY

Data and the Construction of Variables

The present study uses daily data from 11th December, 2002 to 31st October, 2006. The
series are not publicly available and have been obtained from the Treasury of the State
Bank of Pakistan. Data on order flows (NOP) and official intervention in the foreign
exchange market is not publicly available. On account of data limitations, it is not
possible to analyze the whole period. Thus the study uses daily exchange rate and net
foreign exchange purchases from 1 1 December 2002 to 3 1 March 2006.
The daily interbank rate of Pak rupee per US dollar (. P ) is used as the dependent
variable. Interest rate differentials, the difference of six months T-Bills rate and six
months LIBOR rate ( R ), and foreign exchange reserves coverage for imports {IMP) are
used as macroeconomic variables. The present study also takes account of the NOP (X)
and foreign exchange interventions ( INT) of the Pakistani Central Bank to explain the
relative importance of order flow and foreign exchange interventions respectively.
Following the earlier studies such as, inter alia , Canales-Krilijenko (2003) and D'Souza
(2002) used the NOPs and central bank interventions in the foreign exchange market as
an independent variable to explain the theory of market microstructure. We also use a
dummy variable to incorporate the effect of oil price shock of 2004. This is because, the
State bank of Pakistan provided the foreign exchange reserve for the oil payment, which
definitely affected the foreign exchange rate. So D1 is a dummy variable introduced from
1st December 2004 as 1, and 0 elsewhere.
Evans and Lyons (2002) defined the 'order flow' the net of demand-initiated
transactions and supply-initiated transactions. However, data on very high frequency for
the exchange rate and order flow is generally not available for developing countries
including Pakistan. Canales-Krilijenko (2003) suggests that information about the net
open position of the authorized dealer in foreign exchange transactions could also be used
to anticipate change in order. Hence, net open position estimated as the net of demand
initiated amounts and supply initiated amounts, is used to proxy order flow. This variable

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 259

of order flow ( X) is used as a micro variable in the present analysis. According to

Medeiros (2005), the amounts of buying and selling are more accurate indicators of order
flow because the foreign exchange markets are very thin and there are very few big
market players, who can change the sentiments of the market in one major deal.
Additionally, untargeted bidding is a common phenomenon in the foreign exchange
markeť.Untargeted bidding can generate a very irrational number of order flow, based on
the number of buyers and sellers, while the amount of buying and selling do not indicate
the same trend. In other words, amounts are more relevant than the number of buyers and
sellers.

Methodology

The typical macro economic models of exchange rate take the following form:

&Pt = f(Ai , Am,

where A Pt is the change in the log nominal exchange rate over the month. The driving
variables in the function / (Ai, Am,

interest rates i, money supply m, and other macro determinants, denoted here by the error
term. There is no role for 'order flow' that the market related variable in the main
equation. Any incidental price effects from order flow that might arise are subsumed in
the residual et. These models are logically and intuitively appealing. Unfortunately, they
account for almost none of the monthly variation in floating exchange rates and
particularly do not incorporate the market activity aspects of the exchange rate.

On the other hand, equations of exchange rate determination within the

microstructure approach are derived from the optimization problem faced by price setters
in the market that is the dealers of exchange rate as shown by the following specification:

A Pt = g(Ax, AI,

Now A Pt is the exchange rate change over two transactions, rather than over a
month as in the macro models. The driving variables in the function g ((Ax, AI...) include
order flow ( 'Ax , the change in net dealer positions and other micro determinants, denoted
by the error term. The coefficient of order flow can take both positive and negative values
because the counterparty either purchases (+) at the dealer's offer or sells at the dealer's
bid (-). Here Evans and Lyons (2002) use the convention that a positive Ajc is net dollar
purchases, making the theoretical relation positive. This means that the net foreign
currency purchases drive up the local currency price of the foreign currency. That is the
local currency will depreciate. It is interesting to note that the residual in this case is the
mirror image of the residual in equation 1. It includes any price changes due to
determinants in the macro model / ((Ai, Am...), whereas the residual in equation (1)
includes price changes due to determinants in the micro model g ((Ax, AI...).
Microstructure models predict a positive relation between A p and Ax because order flow
communicates non-public information, and once communicated, it is reflected in price.

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 260

Evans and Lyons (2002) mix the macro and micro models. For the macro
economic variable, the authors used the interest rate differential of both local and foreign
currency. Similarly, for the micro variable they utilized the variable 'order flow'. They
come up with the following final equation:

APt=ßAx + ß2 (i, - /,*)+ 7jt (3)

Here A Pt is change in the exchange rate, /, interest rate on the domestic
currency. The /*, is the interest rate on the on the foreign currency. They argue that the
choice of these variables has three main advantages. First, this specification is consistent
with monetary macro models in the sense that these models call for estimating A Pt using
the change in the interest differential as an independent variable. Second, in asset-
approach macro models like the Dornbusch (1982) overshooting model, innovations in
the interest differential are the main engine of exchange rate variation. Third, from a
purely practical perspective, data on the interest differential are readily available at the
daily frequency, which is certainly not the case for the other standard macro
fundamentals for example, real output, nominal money supplies, etc.
Evans and Lyons (2002) suggest that the order flow causes the change in
exchange rate. Hence, causality strictly runs from the order flow to exchange rate. That
is the order flow is exogenous.
However, there are other popular thoughts that argue the opposite that is it is the
change in exchange rate cause the order flow. One of the leading theories, in this regard,
is the feedback trading theory. To answer this question Lyons and Evans (2002)
proposed the following model

APt = ßtAx + ß2Ax_{ + ß3 (z, - i* ) + rjt (4)

APl=ßlAx + ß2APt_x + Д (z, - i* ) + r¡, (5)

The authors claim that, the importance of order flow cannot be neglected, even,
in the presence of the previous price that is the lag value of exchange rate.
Evans and Lyons (2002) estimated their model by simple OLS. But, the
estimation, presentation and defense of the results on the basis of the OLS estimation are
not an easy task for financial variables like exchange rate and interest rate, specially for
longer time series. Because, in some applications there may be reason to believe that the
variance of the error term is not a function of an independent variable but instead varies
over time in a way that depends on how large the errors were in the past. In other words,
there is a particular kind of heteroscedasiticity present in which the variance of the
regression error depends on the volatility of the errors in the recent past. A widely used
model of such heterescedasticity was developed by Engle ( 1 982) who suggested that use
of an Auto Regressive Conditional Heteroscedasticity (ARCH) model would lead to
increased efficiency. The model works as follows.
It begins with the equation

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 261

AP, = Д + ß2X + ß{i, - it )t+s (6)

The equation (6) relates a dependent variable to two independent variables and
the equation (7) relates the variance of the error term to the amount of the volatility
observed in recent periods. The simplest form of such equation would be

ô,2 =a0 +ale2t-i (7)

In the case of this study this equation can be specified in the following fashion

-&o+ + A ('/ ~~ 0 + ßbh- 1 + ßbet~' (8)

Based on these considerations, a number of specifications have been estimated
to explain the explanatory power of order flow. In the models, A represents the difference
operator, P denotes daily inter-bank rate of Pakistani rupee per US dollar, X denotes order
flows, R denotes the interest differentials, IMP denotes foreign exchange reserves
coverage for imports, INT denotes central bank interventions in the foreign exchange
market, and D1 denotes the dummy for the oil price shock of 2004.
Equation 9 consists of order flow, interest rate differential, lagged variable of
exchange rate and the variable:

A Pt =a0+ axX + a2AR + a3Di + a4AP_ j (9)

In equation 10, an alternative model is estimated:

A Pt =a5+ a6X + a -j AR (Ю)

In Equation 1 1, a model without order flow is estimated:

APt=ßo+ ЛАЯ + ß2AP_i (1 1)

In Equation 12, the coverage of foreign exchange reserves for imports (IMP) is used as a
proxy for the macro fundamentals:

APt = y0 + yxX + y2&P-' + У ъ Al MP (12)

In order to capture ARCH effects, the model is estimated using ARCH/GARCH

regression methods instead of OLS. In Equation 13, the model is estimated using
ARCH/GARCH regression method instead of OLS:

A Pt =õ0+SlX + ô2AINT + ô3AIMP+õ4AP_l (13)

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 262

ôf =S5+ S6X, + SjAINT + SsA P_,

and, lastly, the ARCH/GARCH model is re-estimated after dropping the order flow:
APt=e0+ в, M MP + в 2 AI NT + 6>3 A P , (14)
Ô? =в4+ 05A INT + вьАР_,

EMPIRICAL RESULTS

Results of Equation 9 are reported in Table 1. As the table suggests, all variable are
highly significant except the interest rate differential. Nonetheless, although the dummy
is statistically significant, the histogram shows the non-normality in the residuals with the
dummy variable as the distribution is highly leptokurtic. In order to overcome this
problem, we removed some observations that were the outliers in the data set.

TABLE 1. ESTIMATES OF EQUATION 9

Variables Coefficient Std. Error t-States Prob.

a0 1.9E-06 5.2E-07 3.64 0.0003

X 1.0E-07 1.2E-08 8.51 6.8E-17

AR 8.6E-07 2.4E-06 -0.35 7.2E-01

Dl -3.4E-06 7.8E-07 -4.40 1.2E-05

AP_¡ 4.0E-05 9.1E-06 -4.37 1.4E-05

R-squared 0.1058 Durbin-Watson 1.9556

Table 2 shows that there is no major difference in the results except the
improvement in R2 . Importantly, the study gets normality at the cost of loss of some
information". The coefficient of order flow shows low magnitude with positive signs, as
expected. However, R2 is low as compared to Evans and Lyons (2002).

TABLE 2. ESTIMATES OF EQUATION 10

Variables Coefficient Std. Error t-States Prob.

a5 0.01088 0.00167 6.501 2.79E-10

X 0.00052 0.00006 8.133 7.56E-15
AR 0.00476 0.01006 -0.473 0.636

R-squared 0.161 Durbin-Watson stat 1.84166

As Table 3 indicates, when the equation is estimated without order flow the
- value of R2 drops significantly. Results suggest that the interest rate differential does not
explain the change in exchange rate in Pakistan.

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 263

TABLE 3. ESTIMATES OF EQUATION 11

Variables Coefficient Std. Error t-States Prob.

ß0 -6.11E-07 4.45E-07 -1.837 0.0170

AR 7.58E-07 2.52E-06 -0.301 0.763

A P.j 5.51E-05 9.27E-06 -5.947 3.8E-09

R-squared 0.0370 Durbin-Watson stat 1 .997

However there are other options for macro economic variable, like GDP,
inflation etc. but time series data in daily frequency is not available for these variables.
To overcome this problem, the coverage of foreign exchange reserves for imports {IMP)
is used as a proxy for the macro fundamentals. The results of this equation are presented
in Table 4.

TABLE 4. ESTIMATES OF EQUATION 12

Variables Coefficient Std. Error t-States Prob

Уо -8.54E-06 2.31E-06 -3.6985 0.000

X 8.58E-08 1.05E-08 8.173901 0.000

АР.! 3.99E-05 9.15E-06 -4.359656 0.000

A IMP -2.71E-07 7.17E-08 -3.778227 0.000

R-squared 0.101 Durbin-Watson stat 1.952

As can be seen, the signs of all variables are according to a priori expectations
and statistically significant without losing the normality. The present study incorporates
APt-1 the exchange rate with one lag. Evans and Lyons (2002) used this variable to
address the problem of endogeneity. The present study also gets the significant result
with this variable without losing the significance of order flow. That is, the order flow
causes the exchange rate and not vice versa.
The results of ARCH/GARCH regressions are reported in Table 5. The results
show that GARCH model is highly significant in taking care of conditional
heteroskedasticity in the exchange rate. The estimates show that the sign in the mean
equation is according to a priori theory and statistically significant. This may imply that
the role of order flow is effective in altering the exchange rate level. The variance
equation also comes up with priori expectation. Importantly, the magnitude of R2
improved significantly as compared to OLS estimation which shows the superiority of
ARCH/GARCH estimation over OLS in our case.

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 264

TABLE 5. ESTIMATES OF EQUATION 13

Variables Coefficient Std. Error t-States Prob.

âõ 0.00676 0.0014 4.848 0.0000

X 0.00037 4.3E-05 8.584 0.0000
A INT -7.8E-05 2.8E-05 -2.795 0.0052
A IMP -0.01348 0.0044 -3.074 0.0021

A P.j 0.04388 0.05336 0.822 0.4108

Variance Equation
S5 0.00025 4.4E-05 5.69441 1.2E-08
ARCH(l) 0.69696 0.1023752 6.80790 9.9E-12
GARCH(l) 0.19855 0.0590508 3.36239 0.00077
X -1.6E-06 1.4E-06 -1.14844 0.25079
A INT -1.9E-06 9.6E-07 1.95675 0.05038

A P.t 0.0038053 0.0023884 1.59325 0.11110

R-squared 0.15029 Durbin-Watson stat 1.74841

Additionally, the present study estimated ARCH/GARCH model by dropping

the order flow. The results reported in Table 6 suggest that R2 dropped significantly. This
shows the importance of order flow, even in the presence of INT.

TABLE 6. ESTIMATES OF EQUATION 14

Variables Coefficient Std. Error t-States Prob.

в0 0.0025 0.0012 2.0131 0.0441

A IMP -0.011973 0.0063 -1.9093 0.0562
A INT -6.40E-05 0.0000 -1.9889 0.0467

A P.! 0.1722 0.0446 3.8589 0.0001

Variance Equation
в 4 7.38E-05 0.0000 4.1286 3.65E-05
ARCH(1 ) 0.1965 0.0297 6.6283 3.40E-11
GARCH(l) 0.7204 0.0338 21.3169 0
A INT -2.69E-06 0.0000 2.2778 0.0227

A P.j 0.0037 0.0011 3.3605 0.0008

R-squared 0.0567 Durbin-Watson stat 1.8545

CONCLUSIONS AND POLICY IMPLICATIONS

This present article has investigated the exchange rate movements in the Pakistani foreign
exchange market using the market micro structure approach for the first time. As the
theory suggests, the order flow is a key variable that explains the movements in exchange
rate over a short term in case of Pakistan. The significance of order flow suggests that the

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms
 265

exchange rate in Pakistan, particularly in the short run, depends on the micro foundations.
This means that foreign exchange trade related variables such as order flows, NOPs,
Interventions, exposures and news are much important than the macro fundamentals. If
the foreign exchange market becomes more independent and free floating exchange rate
is maintained, then the market can gain more stability. Although the data series of net
open position used in the present article can be used, as a very close proxy for the order
flow, it is still a crude measure. Further analysis based on the intraday volatility and data
based on the very high frequency for the order flow is likely to explain the exchange rate
determination with more clarity. This is left for future work.

ENDNOTES

1 The Author is also Assistant Director in the Research Department of State Bank of Pakistan.
* Acknowledgements: The authors are indebted to Richard Lyons for his helpful comments and
suggestions on an earlier draft of this article.

1 Untargeted bidding means that when a dealer just the rate from the other rate without committing
the deal. This, just asking the rate, generates expectations about excess demand and excess supply.
" We do not mention the Histogram and results of Outliers tests due to brevity. However these can
be produced on request.

REFERENCES

Andersen, T. G., Bollerslev, T., Diebold, F. X. and Vega, C. (2007) "Real-time

price discovery in global stock, bond and foreign exchange markets" Journal of
International Economics , 73, 251-277.
Canales-Krilijenko, J. I. 2003. "Foreign Exchange Intervention in Developing
and Transition Economies: Results of a Survey" IMF Working WP/03/95
Dornbusch, R. 1982. "Equilibrium and Disequilibrium Exchange Rare", NBER
Working Paper No 983
D'Souza, C. 2002. "A Market Microstructure Analysis of Foreign Exchange
Intervention in Canada", Bank of Canada Working Paper No 2002-16.
Engle, Robert F. 1982. "Autoregressive Conditional Heteroskedasticity with
Estimates of the Variance of U.K. Inflation", Econometrica 50, 987-1008.
Evans, M. and Lyons, R. K. 2002. "Order Flow and Exchange Rate Dynamics"
Journal of Political Economy 1, 170-80.
Evans, M. and Lyons, R. K. 2008. "How is macro news transmitted to exchange
rates?" Journal of Financial Economics, 88, 26-50.
Frommel, M., Mende, A. and Menkhoff, L. 2007. "Order flows, news, and
exchange rate volatility" Journal of International Money and Finance (article in Press,
available online: 27 July 2007).
Gradojevic, N. 2007. "The microstructure of the Canada/U.S. dollar exchange
rate: A robustness test" Economics Letters, 94, 426-432.
Love, R. and Payne, R. 2008. "Macroeconomic News, Order Flows, and
Exchange Rates " Journal of Financial and Quantitative Analysis 43, 467-488.

This content downloaded from 128.111.121.42 on Sat, 07 May 2016 14:22:50 UTC
All use subject to http://about.jstor.org/terms