Order Flow

Order Flow, Market Making and Exchange Rates: Costa Rica's Monex Market

The cornerstone result of the market microstructure literature to FX markets is that the order flow (the difference between buyer-initiated and seller-initiated transactions) is a key determinant of the exchange rate short run dynamics. This paper advocates to study the short term dynamics of the Costa Rican Colón to United States Dollar exchange rate generated in the Monex market by employing market microstructure tools.Using transaction level data for 729 trading days we have gathered evidence that the order flow has explanatory power on the short term dynamics of exchange rate returns, even after accounting for a feedback effect. Additionally we show evidence suggesting that the informational content of the order flow has persistent effects. Finally when characterizing the role of the interventions by the monetary authority on the market, data shows that interventions affect the informational content of the order flow and that the monetary authority acts as a liquidity provider and a market maker in the Monex platform.