We analyze the association between order flow and exchange rates using a new dataset representing a majority of global interdealer transactions in the two most-traded currency pairs. The data consist of six years (1999-2004) of order flow and exchange rate data for the euro-dollar and dollar-yen currency pairs at the one-minute frequency from EBS, the electronic broking system that now dominates interdealer spot trading in these currency pairs. This long span of high-frequency data allows us to gain new insights about the joint behavior of these series. We first confirm the presence of a substantial association between interdealer order flow and exchange rate returns at frequencies ranging from one minute to one week, but, using our long span of data, we find that the association is weaker at lower frequencies, with far less long-term association between cumulative order flow and long-term exchange rate movements. We study the linearity and time-variation of the association between high-frequency exchange rate returns and order flow, and document an intradaily pattern to the relationship: it is weakest at times when markets are most active. Overall, our study tends to support the view that, while order flow plays a crucial role in high-frequency exchange rate movements, its role in driving long-term fluctuations is much more limited.
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