A hybrid approach to exchange rate dynamics: How do macro variables and order flow affect the Norwegian Krone?

Abstract

This paper investigates the relationship between the EURNOK spot exchange rate, macroeconomic factors, and order flow. We consider an error correction model framework using almost 16 years of data. At a weekly frequency, we establish a link between the EURNOK depreciation rate and changes in the 3–month interest rate di↵erential between Norway and the Euro area, the Brent Crude Oil price, and volatility in the financial market. Our findings confirm that di↵erent end–user order flows are empirically important drivers of movements in the exchange rate and convey additional information. The results are stable across subsamples, and in an out–of–sample fit exercise, we present evidence that the hybrid model outperforms the random walk benchmark.