Essays on the Determinants of Foreign Exchange Rates
Date Issued
2012
Date
2012
Author(s)
Chien, Chih-Chung
Abstract
The purpose of this dissertation is to investigate the determinant of the foreign exchange rate according to the microstructure and macroeconomic theory. In particular, this dissertation proposes three essays in order to (1) investigate what roles of the order flow and liquidity factors play on the dynamics in the daily foreign exchange rates by estimating the unified model, (2) examine whether the consumption growth differential across the countries with the covered interest rate parity model can explain the change in the weekly foreign exchange rates.
In Chapter 2, we aim to demonstrate why liquidity factors should be involved in the daily order flow model. We develop a unified model to show explicitly how the order flow and realized bid-ask spread affect the foreign exchange rate when trading density is different. Toward this end, robust estimation of the generalized method of moments is proposed. The proposed model is designed to reexamine the consistent estimates of our unified model with the order flow and the bid-ask spread. Empirically, our results provide consistent evidence that both order flow and liquidity factors play important roles in the determinant of the daily foreign exchange rate. Our findings suggest that the order flow model is better at incorporating these microstructure effects except for some currencies with a very high level of trading density.
In Chapter 3, we discuss the ability of the information transmission of the order flow for major three currency pairs with the distinct heterogeneous information and liquidity. Our proposed model is designed to analyze the explanatory power of the order flow by using the price clustering and trade-size clustering measures to divide the total observations into the 3 by 3 matrix. In particular, heterogeneous information and liquidity are estimated by introducing measures under the setting of the price clustering and trade-size clustering in the imperfect foreign exchange rate markets. We find that traders prefer to trade when foreign exchange market is in the high heterogeneous information and the high liquidity. This result can be explained by the hidden information to reveal less information to other traders and the demand of liquidity to avoid the execution uncertainty.
In Chapter 4, we investigate whether the consumption growth differential is involve in the covered interest rate parity when there is an invalid estimate of the interest rate differential caused by the forward premium puzzle. Empirically, we show that our proposed model is able to reduce the estimating bias caused by the forward premium puzzle.
Subjects
Microstructure
Order flow
Liquidity
Bid-ask spread
Trading density
Heterogeneous information
Consumption growth differential
Type
thesis
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