Dynamics of exchange rate determination and currency order flow in the Thailand foreign exchange market. An empirical analysis
| DOI | https://doi.org/10.1108/JCEFTS-11-2016-0031 |
| Published date | 05 June 2017 |
| Date | 05 June 2017 |
| Pages | 143-161 |
| Author | Abolaji Daniel Anifowose,Izlin Ismail,Mohd Edil Abd Sukor |
| Subject Matter | Economics,International economics |
Dynamics of exchange rate
determination and currency order
flow in the Thailand foreign
exchange market
An empirical analysis
Abolaji Daniel Anifowose,Izlin Ismail and Mohd Edil Abd Sukor
Department of Finance and Banking, University of Malaya,
Kuala Lumpur, Malaysia
Abstract
Purpose –The purpose of this paper is to present the essential role that currency order flow plays in the
foreign exchange markets of emerging economies in the determination of their currencies in the short and
the long-run against major currencies of the world, which cannot be over emphasized, most especially
against the US dollar. Insomuch that, if some of these emerging economies can be successfully transmitted
into full development, it would be a good model for other emerging economies and the world at large.
Design/methodology/approach –A hybrid model(portfolio shift model)proposed by Evans and Lyons
(2002a,2002b) is extendedto analyze a data set of every quarter of an hour currency order flow andcurrency
exchange rate fluctuations of Thai Baht (THB) against the US$ for the pe riod of six years (January 2010 to
December2015). To reflectthe pressure of currencyexcess demand,the authorsconstruct a measureof currency
order flow in theThailand currency exchange market. Vector autoregression model is applied to estimatethe
effectualrole of currencyorder flow in the determination ofexchange rate forthe THB against the US$.
Findings –Currencyorder flow indeed accounted for a sizeable and significant portion of the fluctuationsin
the THB and the US$ exchange rate.
Originality/value –Insomuch that, the results show thatcurrency order flow has significant explanatory
power in the emerging marketseconomy to capture the THB exchange rate variability,and it then brings to
the attention of the Thailand Monetary Authority the importance that should be attached to the market
microstructure.
Keywords Currency exchange market, Currency exchange rate, Currency order flow,
Market microstructure
Paper type Research paper
Introduction
The experiential study of the asset market method reveals the manner in which traditional
models of currency exchange rate determination completely go on the blink to elucidate
exchange rate movements in the short term. In the other words, it can only indicate long-
term trends (Vitale, 2003). Hence, both the financial economist and international finance
researchers now give more consideration to the organizationof currency exchange markets.
Furthermore, with the knowledge that the market microstructure theory actually
investigates dealers’behavior in the securities market has led the academics in the field of
economics to suggestthat, such a theory may guide in the foreign exchange markets.
O’Hara (1995) defines market microstructure“as the study of the process and outcomes
of exchanging assets under explicit trading rules”. Therefore, dealing in securities market
Thailand
foreign
exchange
market
143
Journalof Chinese Economic and
ForeignTrade Studies
Vol.10 No. 2, 2017
pp. 143-161
© Emerald Publishing Limited
1754-4408
DOI 10.1108/JCEFTS-11-2016-0031
The current issue and full text archive of this journal is available on Emerald Insight at:
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has essential consequences while determiningthe price at which deals are consummated. It
can be rightly said that,this understanding is real for currency exchange markets in a sense.
The traditional models of exchange rate determination actually based on two basic
fundamental principles:
(1) currency exchange rate determination is mainly macroeconomic variableoccurrence,
i.e. changes in macroeconomic variables aggregatesexclusively determine exchange
rate movements;and
(2) currency exchange rates instantaneously react to changes in macroeconomic
variables aggregates.
However, inadequate explanatory capability of these traditional models together with the
experiential proof revealing the significance of micro-structure parts of the stock market
while given explanation to short-term fluctuations in stock prices have made researchers to
concentrate on order flowin the foreign exchange markets.
Order flow is defined as the net of the buyer-initiated and seller-initiated orders in the
foreign exchange market (Evans and Lyons,2002a, 2002b). Currency order flow represents
the measure of net buying pressure. Insomuch that, currency order flow may as well be
inferred to be a communicationnexus that links information and currency exchangerates in
the foreign exchange market, as it sends information meaningful enough on the
determination of currency exchange rates, for markets aggregation and subsequently
impounding this information inthe value of currencies. These currency order flows are the
driving force behind the turnover in the currency exchange market (Evans and Lyons,
2002a, 2002b).
Researchers in this field of international finance concentrated majorly on matured
economies and the world currency pairs, but a small number of studies have investigated
the essential role currency order flow playsin the foreign exchange markets in the emerging
markets.
Thailand, an industrialized country, also heavily export-dependent, with exports
accounting for more than two-thirdsof the country’s gross domestic product, has made the
country to be one of the most robust in Asia. In the recent years, international trade has
become increasingly important to this nation, having the main trading partners like the
USA, ASEAN, EU and Japan. It is interesting that the exports to the USA are the highest
compared to other trading partners to this one of the fastestgrowing countries in the world.
Also, being the second largest economy in the Southeast Asia, Thailand has been a front-
runner in the region in relations to trade liberalization and facilitation with the rest of the
world. With Thailand, enormous trade transactions with the USA, her currency ought to
appreciate in value and to a reasonable degree, achieve exchange rate stability in the
international market. However, the continuous reduction in the foreign reserves of the
country and subsequent currency depreciation in the international market, especially,
against US dollar (US$) is worrisome. With the country daily turnover of inter-bank and
customer transactions in the spot and forward market averages around US$3bn, this is
considerably large compared to otherfinancial markets. Therefore, it is paramount that, we
should know how the value of Thai Baht (THB) against the US$ is determined in the
international currency market, in the short run and long run, respectively. More so, if this
emerging economycan be successfully transmitted into full development,it would be a good
model for other emerging economiesand the world economy at large.
A data set for everyquarter of an hour currency order flow and exchangerate fluctuations
for the periodof six years (January 2010to December 2015) is analyzedusing hybrid model of
order flow and exchange rate dynamics proposed by Evans and Lyons (2002a,2002b).
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