Order flow and the Polish zloty : an empirical investigation

Abstract

This paper analyses price variations in the euro-zloty and dollar-zloty ex- change rates. Drawing from market microstructure, we use order ow|signed buy and sell orders|to model price variations. Our work adds support to the thesis that order ow is important in understanding exchange rate uctua- tions. We look at two subsamples: pre and post May 2004, when Poland joined the European Union. Poland kept its own currency, the zloty, which experienced a structural shift in trading|from the dollar to the euro as main trading currency. At the most, order ow explains 29 percent of the variation in the zloty price of the euro. Moreover, we nd that euro-zloty order ow is a better proxy for price-relevant information than the dollar-zloty order

ow. Coe cient analysis shows that our model provides more statistically signi cant results in the post May 2004 sample for the euro-zloty equation. Variations in order ow explain variations in exchange rates, both over time and across di erent currencies. Our ndings are important for understanding currencies that experience similar structural shifts as the zloty experienced when the euro became its main vehicle currency.