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Market Microstructure Approach to the Exchange Rate Determination Puzzle

Author

Listed:
  • Thabo M Mokoena
  • Rangan Gupta
  • Renee van Eyden

Abstract

Market microstructure approach claims that the imbalances between ‘buyer-initiated and seller-initiated trades’ in foreign exchange markets are indicative of the transmission link between exchange rates and fundamental determinants of exchange rates. In the context of the exchange rate determination puzzle, this paper uses Autoregressive Distributed Lag (ARDL) model to discuss the market microstructure approach from the standpoint of hybrid models that integrate order flow, fundamentals and non-fundamental variables to establish the determinants of the rand-dollar exchange rate. Among the non-fundamentals considered are the Economist’s commodity price index, and a proxy for country risk—the differential between the Global Emerging Market Bond Index and the South African long-term bond. The results, based on the Schwarz Bayesian Criterion, used for choosing a model’s lag length, show that there is a long-run relationship between the rand-dollar real exchange rate, non-fundamentals, fundamentals and the proxy for order flow, which is the dollar-denominated daily net turnover in the South African markets.

Suggested Citation

  • Thabo M Mokoena & Rangan Gupta & Renee van Eyden, 2009. "Market Microstructure Approach to the Exchange Rate Determination Puzzle," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(3-4), pages 101-115, August.
    • Handle: RePEc:icf:icfjmo:v:07:y:2009:i:3-4:p:101-115
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    Cited by:

    1. Thabo M. Mokoena & Rangan Gupta & Reneé Van Eyden, 2009. "Testing For Ppp Using Sadc Real Exchange Rates," South African Journal of Economics, Economic Society of South Africa, vol. 77(3), pages 351-362, September.
    2. Katusiime, Lorna & Shamsuddin, Abul & Agbola, Frank W., 2015. "Macroeconomic and market microstructure modelling of Ugandan exchange rate," Economic Modelling, Elsevier, vol. 45(C), pages 175-186.

    More about this item

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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