Working Paper – WP/17/03: Order flow and rand/dollar exchange rate dynamics
Aadila Hoosain, Alta Joubert and Alain Kabundi
Last Modified Date:
2020-10-01, 09:31 PM
Publications > Working Papers
This paper uses the microstructure approach for the South African foreign exchange market to determine the impact of order flow on the rand/US dollar exchange rate over the short and long term. A hybrid model which combines microeconomic and macroeconomic fundamental determinants of the exchange rate has been adopted. The analysis uses monthly series from January 2004 to December 2016 and finds that order flow explains movements in the exchange rate, both in the short and in the long term. The speed of adjustment from short-term deviations is relatively slow. The results based on the rolling-window estimation of the long-run model provide evidence of a changing relationship between order flow and the exchange rate. Consistent with the literature, the results show that the rand/dollar exchange rate reacts to fundamental variables only in the long term. Unlike Meese and Rogoff (1983), who postulate that the best way to estimate the exchange rate over the short term is with a random walk model, the current study shows that the microstructure approach can be exploited to explain short-term dynamics in the exchange rate.