Exchange Rate Dynamics Based On US Economic News And Foreign Exchange Order Flow

For global foreign exchange investors,it is critical to understand the relationship of macrostructure,microstructure,and foreign exchange market behavior.Moreover,more and more macro and micro variables have been used to study the volatility of foreign exchange market.However,previous research is ambiguous and imprecise regarding the impact and interaction of market participants’ trading activities and economic news on market volatility.The aim of this research,which is divided into three studies,is to investigate the co-movement and interconnection between US economic news in seven different categories and the exchange rate of the US dollar against the currencies of seven developed countries,with the corresponding order flows.In the first study,we employ a novel approach to evaluate the behavior patterns of exchange rate movements and market participants in response to US economic news events across a one-day,four-hour,and one-hour period prior to and following the announcement of the event,as well as during the announcement.That is,using rank correlation analysis,the positive impacts of US economic news on the exchange rate can be classified as pre-release effects,immediate post-release effects,long-term postrelease effects,and both pre-and post-release effects for various macroeconomic indicators.In the US economic news,the trade balance,nonfarm payrolls,ISM nonmanufacturing PMI,GDP price index,factory orders,and wholesale inventories have the most significant effect on the exchange rate trend.The second study uses wavelet transform coherence in the time and frequency domains to evaluate the relationship between changes in US economic news,exchange rates,and corresponding order flow.The bivariate coherence results demonstrate that economic news has a short-term effect on price fluctuations that fades over time.Moreover,we show that over longer time periods,order flow exhibits greater coherence than economic news,and consistent co-movement is observed against the exchange rate.Throughout the sample period,wavelet coherency reveals that the lead-lag effect of order flow on price fluctuations begins in the medium-frequency bands and progresses to the low-frequency bands.In addition,economic news weakens the correlation between exchange rate and order flow in the short run,which means that the combination of economic news and order flow can achieve a higher degree of consistency with the exchange rate.In the third study,as a robustness test,we extend the traditional market microstructure model to predict the future trend of the US dollar bilateral exchange rates with macroeconomic news.The proposed approach involves several supervised learning classification methods called decision trees,support vector machines(SVMs)with Gaussian kernel function,k-nearest neighbors(k-NN),and ensembles.These techniques allow investigation of the predictive power of order flow and economic news in forecasting currency exchange rate movements one hour,four hours,and one day after the arrival of US economic news.The robustness testing indicates that order flows appear to be more accurate at forecasting exchange rate changes than US economic news,and a hybrid model that incorporates both order flows and economic news increases forecasting accuracy for the majority of US dollar bilateral exchange rates.Additionally,the model also effectively describes the direction of exchange rates.This dissertation,in contrast to existing macroeconomic fundamental analysis models of the exchange rate,provides insight into the behavior of exchange rate movements in the medium and short run,considering the periods prior to,during,and following the release of macroeconomic news.Moreover,we extend the hybrid model of Evans and Lyons by examining the association between macroeconomic news,order flow,and the exchange rate using phase analysis.This clarifies the relationship between variables in time and frequency,and we demonstrate that,contrary to the random walk theory,the future trend of the exchange rate can be predicted in the short run using a hybrid model and in the medium and long run using order flow.The empirical implication of this study is that macro policymakers,import and export enterprises,foreign exchange investors,and exchange fund managers can predict future exchange rates using a hybrid model to help select hedging strategies under different objectives.