a b s t r a c tThis paper adds to the research efforts that aim to bridge the divide between macro and micro approaches to exchange rate economics by examining the linkages between exchange rate movements, order flow and expectations of macroeconomic variables. The basic hypothesis tested is that if order flow reflects heterogeneous expectations about macroeconomic fundamentals, and currency markets learn about the state of the economy gradually, then order flow can have both explanatory and forecasting power for exchange rates.Using one year of high frequency data collected via a live feed from Reuters for three major exchange rates, we find that: i) order flow is intimately related to a broad set of current and expected macroeconomic fundamentals; ii) more importantly, order flow is a powerful predictor of daily movements in exchange rates in an out-of-sample exercise, on the basis of economic value criteria such as Sharpe ratios and performance fees implied by utility calculations.

Arbitrage in the Foreign Exchange Market:Turning on the Microscope* This paper provides real-time evidence on the frequency, size, duration and economic significance of arbitrage opportunities in the foreign exchange market. We investigate deviations from the covered interest rate parity (CIP) condition using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency. The analysis unveils that: i) short-lived violations of CIP arise; ii) the size of CIP violations can be economically significant; iii) their duration is, on average, high enough to allow agents to exploit them, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.JEL Classification: F31, F41, G14 and G15

We study dealer behavior in the foreign exchange spot market using a detailed data set on the complete transactions of four dealers. There is strong support for an information effect in incoming trades. Although there is evidence that the information effect increases with trade size in direct bilateral trades, the direction of a trade seems to be more important. The large share of electronically brokered trades is probably responsible for this finding. In direct trades it is the initiating dealer that determines trade size, while in broker trades it is the dealer submitting the limit order that determines the maximum trade size. We also find strong evidence of inventory control for all the four dealers. Inventory control is not, however, manifested through a dealer's own prices as suggested in inventory models. This is different from the strong price effect from inventory control found in previous work by Lyons [J. Fin. Econ 39(1995) 321]. A possible explanation for this finding is that the introduction of electronic brokers allowed more trading options. Furthermore, we document differences in trading styles among the four dealers, especially how they actually control their inventories.

Abstract:We presents evidence that non-financial customers are the main liquidity providers in the overnight foreign exchange market using a unique daily data set covering almost all transactions in the SEK/EUR market over almost ten years. Two main findings support this: (i) The net position of nonfinancial customers is negatively correlated with the exchange rate, opposed to the positive correlation found for financial customers; (ii) Changes in net position of non-financial customers are forecasted by changes in net position of financial customers, indicating that non-financial customers take a passive role consistent with liquidity provision.

Arbitrage in the Foreign Exchange Market:Turning on the Microscope* This paper provides real-time evidence on the frequency, size, duration and economic significance of arbitrage opportunities in the foreign exchange market. We investigate deviations from the covered interest rate parity (CIP) condition using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency. The analysis unveils that: i) short-lived violations of CIP arise; ii) the size of CIP violations can be economically significant; iii) their duration is, on average, high enough to allow agents to exploit them, but low enough to explain why such opportunities have gone undetected in much previous research using data at lower frequency.JEL Classification: F31, F41, G14 and G15