Order flow and exchange rate dynamics in emerging economies: The case of Ghana
The aim of this thesis is to study customer order flow and its impact on a small open emerging economy in Sub-Saharan Africa. Customer order flow, as a key concept in the microstructure approach to exchange rate, deals with signed transaction volumes between market-makers and their customers. The study specifically attempts to explore what the data tells us about the role of customer order flow in the market for local currency (Ghanaian CEDI) using the standard analytical framework of FX microstructure literature. The study also examines short-run exchange rate dynamics in an emerging market based on the recent microstructure framework of foreign exchange markets where the main explanatory variable is the order flow. First, the study modifies the model to take account of a unique feature of the majority of emerging markets, namely the existence of a parallel market for FX. Secondly, it uses a unique proprietary database covering almost the complete Ghanaian market, and for a long time span compared to previous studies, which uses data for a single market-maker and for a short period of time. The study confirms contemporaneous relationship (between flows and exchange rate) suggested by previous literature (Evans and Lyons 2002a) but we also observe a lagged interaction between order flow and exchange rates. These lagged effects are due to the delays in the price transmission which are associated with inefficiencies. Additionally, the study confirms the connection between the price impact of the order flow and the degree of liquidity in the FX market. Furthermore, our findings corroborate the fact that in Ghana, banks provide liquidity to their customers in the short-run whiles the central bank acts a liquidity provider in the long-run. Finally, our results confirm that there exists a strong relationship between order flow, commodity prices and macroeconomic fundamentals in an emerging economy.
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