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Exchange Rate Determination and Dynamics in China: A Market Microstructure Analysis

Zhang, Z.; Chau, F.; Zhang, W.

Exchange Rate Determination and Dynamics in China: A Market Microstructure Analysis Thumbnail


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Abstract

This paper provides a market-microstructure analysis of exchange rate dynamics in the Chinese foreign exchange market using a vector autoregressive (VAR) modeling framework. An index of order flow is constructed in the Chinese context to reflect excess demand pressure in the foreign exchange market. The VAR model is then estimated to examine whether, and to what extent, order flow influences the long-term level and short-term fluctuations of the Chinese exchange rate. Focusing on the relationship between cumulative order flow and the exchange rate of the Chinese renminbi (RMB) against the US dollar, we find that order flow as a measure of excess demand pressure explains a significant part of the fluctuations in the RMB–dollar exchange rate. Specifically, the results show that there is a long-term cointegrating relationship among the order flow, macro factors and the exchange rate. Overall, these findings are important in understanding the role of order flow in exchange rate determination and bear important implications for practitioners and market regulators.

Citation

Zhang, Z., Chau, F., & Zhang, W. (2013). Exchange Rate Determination and Dynamics in China: A Market Microstructure Analysis. International Review of Financial Analysis, 29, 303-316. https://doi.org/10.1016/j.irfa.2012.08.005

Journal Article Type Article
Publication Date Sep 1, 2013
Deposit Date Sep 14, 2012
Publicly Available Date Mar 4, 2015
Journal International Review of Financial Analysis
Print ISSN 1057-5219
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 29
Pages 303-316
DOI https://doi.org/10.1016/j.irfa.2012.08.005
Keywords Exchange rates, Microstructure, Order flow, Foreign exchange.
Public URL https://durham-repository.worktribe.com/output/1473137

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Copyright Statement
NOTICE: this is the author’s version of a work that was accepted for publication in International Review of Financial Analysis. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in International Review of Financial Analysis, 29, September 2013, 10.1016/j.irfa.2012.08.005.





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