Exchange rate determination and inter–market order flow effects

The dependence of foreign exchange rates on order flow is investigated for four major exchange rate pairs, EUR/USD, EUR/GBP, GBP/USD and USD/JPY, across sampling frequencies ranging from 5 minutes to 1 week. Strong explanatory power is discovered for all sampling frequencies. We also uncover cross-market order flow effects e.g. GBP exchange rates are very strongly influenced by EUR/USD order flow. The Meese and Rogoff (1983a,b) framework is used to investigate the predictive power of order flow for exchange rate changes and it is shown that the order flow specifications reduce RMSEs relative to a random walk for all exchange rates at high-frequencies and for EUR/USD and USD/JPY at lower sampling frequencies.