DP4806 Macroeconomic Order Flows: Explaining Equity and Exchange Rate Returns

Author(s): Peter Dunne, Harald Hau, Michael Moore
Publication Date: December 2004
Keyword(s): equities, exchange rates, international macroeconomics, microstructure
JEL(s): F30, F31, G10, G15
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4806

Macroeconomic models of equity returns perform poorly. The proportion of daily index returns that these models explain is essentially zero. Instead of relying on macroeconomic determinants, our model includes a concept from microstructure order flow. Order flow is the proximate determinant of price in all microstructure models. We explain aggregate equity returns as well as exchange rates in a model with heterogenous beliefs. Belief changes are shown to be observable through order flow. To test the model we construct daily aggregate order flow data from all equity trades in the U.S. and France from 1999 to 2003. Almost 60% of the daily returns in the S&P100 index are explained jointly by exchange rate returns and macroeconomic order flows.