International Order Flows: Explaining Equity and Exchange Rate Returns

34 Pages Posted: 13 Mar 2006

See all articles by Michael Moore

Michael Moore

University of Warwick - Warwick Business School

Peter G. Dunne

Central Bank of Ireland

Harald Hau

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: January 2006

Abstract

Macroeconomic models of equity and exchange rate returns perform poorly. The proportion of daily returns that these models explain is essentially zero. Instead of relying on macroeconomic determinants, we model equity price and exchange rate behavior based on a concept from microstructure - order flow. The international order flows are derived from belief changes of different investor groups in a two country setting. We obtain a structural relationship between equity returns, exchange rate returns and their relationship to home and foreign market order flow. To test the model we construct daily aggregate order flow data from all equity trades in the U.S. and France from 1999 to 2003. Almost 60 percent of the daily returns in the S&P100 index is explained jointly by exchange rate returns and aggregate order flows. The model implications are also validated for intraday returns.

Keywords: Market Interdependence, Heterogeneous Beliefs, Order Flow, Equity Return Parity

JEL Classification: F31, G15

Suggested Citation

Moore, Michael John and Dunne, Peter G. and Hau, Harald, International Order Flows: Explaining Equity and Exchange Rate Returns (January 2006). WBS Finance Group Research Paper No. 55, Available at SSRN: https://ssrn.com/abstract=890244 or http://dx.doi.org/10.2139/ssrn.890244

Michael John Moore (Contact Author)

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

Peter G. Dunne

Central Bank of Ireland ( email )

P.O. Box 559
Dame Street
Dublin, 2
Ireland

Harald Hau

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

Swiss Finance Institute

Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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