Order flow and exchange rate changes: A look at the NZD/USD and AUD/USD
In this paper, we apply a series of empirical microstructure tests to the NZD/USD and AUD/USD. In contrast to a more traditional macro approach to explaining exchange rate changes, microstructure studies focus on the role that transactions play in helping the market aggregate information on individual market participants expectations of economic fundamentals and risk preferences. Our data comes from the Reuters Spot Matching service, the main interbank trading platform in both currency pairs, and covers almost five and a half years of transactions from January 2001 to March 2006, a much longer and more representative time series than many empirical microstructure applications to date. We find that there is a strong contemporaneous relationship between net order flow (the net of buyerinitiated and seller-initiated transactions) and changes in the NZD/USD and AUD/USD at frequencies from one minute to one week, similar to studies on other currencies. We also find that cross-currency order flow has a positive association with changes in the other exchange rate (ie AUD/USD order flow has a positive contemporaneous relationship with changes in the NZD/USD). Finally, we examine a wide range of New Zealand, Australian and US data releases and central bank interest rate decisions and find that order flow plays an important role in communicating different interpretations of macroeconomic news.
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