Order flows in the foreign exchange market and the intrinsic value of the Nuevo Sol

This paper explores the relationship between the exchange rate and order flows in the forex market, by using a new high frequency database for the Peruvian market. To this end, we decompose the dollar excess return (i.e., depreciation plus the interest rates differential) into shocks to its intrinsic value and to expectations. We document an important correlation, around 20% and 30%, between the order flows and the excess return, as well as comovements between the order flows and expected returns, both in the short and long run. It is argued that these relationships emerge because the order flows aggregate and transmits to the market private information on the state of the economy. The order flows, in particular, are able to predict future interest rate differentials. (Audio: Department of Economic Publications)