A study on micro structures in indian foreign exchange market and the role of central bank

• Journal: Global Academic Society Journal: Social Science Insight, Vol. 2, No. 6, year 2009, pp. 4-23.
• Author(s): Tilak Mukhopadhyay
• Category: Social Science Insight II
• Keywords: exchange rate, order flows, interest rate, market microstructure theory, foreign exchange market, money market, central bank, Reserve Bank of India (RBI), Federal Reserve Board (Fed), India

Abstract

The present study examines the relevance of macroeconomic models vis-à-vis models based on the market microstructure theory in the context of short-run behaviour of the Indian foreign exchange market. In specific, the paper aims to investigate the relative importance of macro (domestic interest rates) and micro (order flows and number of transactions) variables in determining the short-run exchange rate movements. Empirical analysis is based on secondary data of Indian foreign exchange market and money market.
Analysis of the secondary data reveals that micro variables (order flow) have a stronger impact on the exchange rate movement compared to macro fundamentals. In long run the macro variables have significant effect on exchange rate movements but in the short run the market is basically influenced by the micro variables such as market movement, speculation, Central Bank intervention, etc. One of the major findings of this study would be that the Central Bank intervention has a major impact on speculations and hence it reduces volatility but increases market inefficiency.