Exchange Rate Determination and Forecasting: Can the Microstructure Approach Rescue Us from the Exchange Rate Disparity?

Using two measures of private information and high-frequency transaction data from the leading interdealer electronic broking system Reuters D2000-2, we examine the association between exchange rate return and contemporaneous order flow and the predictability power of lagged order flow on the future exchange rate return. Our empirical analysis demonstrates that at high frequency (5, 10, 15, 20, 25, and 30 min) there exists strong positive association between exchange rate returns and contemporaneous order flow. However, the results indicate weak predictability of order flow on the future exchange rate return.