Essays in Honour of Charles Goodhart, Volume Two
Edited by Paul Mizen
Mintao Fan and Richard K. Lyons* 1. INTRODUCTION Professor Goodhart’s impact has been substantial in many areas. One of those areas is a growing ﬁeld that uses tools from microstructure ﬁnance to analyse exchange-rate behaviour (the ‘microstructure approach’ to exchange rates). This chapter is an introduction to one of the frontiers of that ﬁeld. It addresses the trading of FX customers: investors, importers, exporters, corporate Treasurers, and so on. Past work within the microstructure approach has focused on FX trading between banks, or ‘interdealer’ trading. It is true that most of the trading in FX is interdealer. Nevertheless, interdealer trading is in a sense derivative: it is the demands of non-dealer customers that represent underlying demand for currencies in the real economy. Data necessary for this analysis have become available only recently, in part due to the wholesale shift to electronic trading (and the data capture it permits). Our main results include the following. First, we ﬁnd that aggregate customer order ﬂow in our sample (10–15 per cent of the market-wide total) shows little evidence of mean reversion.1 Indeed, customer order ﬂow cumulated over time is approximately a random walk. Second, aggregate customer order ﬂow tracks exchange rate movements at lower frequencies (for example annual) rather closely. Third, when aggregate customer order ﬂow is disaggregated, we ﬁnd that the parts behave rather diﬀerently. For example, our case study on the 10 per cent drop in the yen/$ rate that occurred in a single day in 1998 (around the...
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