Research On The Micro - Mechanism Of Fundamental "News" Influencing Exchange Rate

In order to further understand the essential characteristics and internal structure of exchange rates, this paper reviews the relationships among macro fundamentals, order flow and exchange rates from the micro perspective, and explains the following two questions: why traditional exchange rates determination model lacks explanatory power for the short‐term exchange rate fluctuations; can fundamentals affect the exchange rates through order flows.The explanation for “exchange rate disconnect puzzle” can be summarized as the following three major aspects: First, the “heterogeneity” of expectation of trade dealers results in different weights to same model variables; Second, the non‐uniform process of information will make the dynamic process of exchange rate exists nonlinear characteristics, which leads to the explanation failure of traditional exchange rate models; Third, the transfer “lagging” means that the dispersed information can only affect the equilibrium exchange rate after it transfers into consensus information. This paper argues that the fundamental information can reflect on the short term fluctuation of exchange rates through two channels: the one is in irrelevant with order flow, which means macro information can reflect on the currency price changes directly; the other one is through trade process, which means macro information can change the order flows and has indirect impact on the currency price. Referring to the “News Model” and “Micro Structure Model”, this paper introduces “expectations” to connect fundamental “News” and order flow, and establishes simultaneous equations by quoting dummy variable as fundamental “News”. The empirical results show that fundamental “News” has a significant effect on the order flow, the explanation power of the model for exchange rates fluctuation and order flow fluctuations have reached55.9%and57.8%separately.The research for the above questions can not only help explain the “disconnection puzzle” and clear the relation between fundamentals and short‐term exchange rates fluctuations, but also provides decision basis for central bank and dealers.