Crash-neutral currency carry trades

Currency carry trades exploiting violations of uncovered interest rate parity in G10 currencies deliver significant excess returns with annualized Sharpe ratios equal to or greater than those of equity market factors (1990–2012). Using data on out-of-the-money foreign exchange options, I compute returns to crash-hedged portfolios and demonstrate that the high returns to carry trades are not due to peso problems. A comparison of the returns to hedged and unhedged trades indicates crash risk premia account for at most one-third of the excess return to currency carry trades.     

Carry trade strategies based on option-implied information: Evidence from a cross-section of funding currencies

We document carry trade returns based on the moments extracted from options on the underlying currencies. We establish three important results. First, a currency pair is predicted to have greater excess returns if option-implied returns are more volatile, are more left-skewed, and have fatter tails than the returns of other currency pairs. Second, strategies based on option-implied information improve on benchmark strategies based on realized market returns and macroeconomic data. Third, if the option-implied returns of a currency pair are more left-skewed than in the past, anti-carry trades rather than carry trades perform better.     

Predictability of currency carry trades and asset pricing implications

This paper studies the time series predictability of currency carry trades, constructed by selecting currencies to be bought or sold against the US dollar, based on forward discounts. Changes in a commodity index, currency volatility and, to a lesser extent, a measure of liquidity predict in-sample the payoffs of dynamically re-balanced carry trades, as evidenced by individual and joint p-values in monthly predictive regressions at horizons up to six months. Predictability is further supported through out-of-sample metrics, and a predictability-based decision rule produces sizable improvements in the Sharpe ratios and skewness profile of carry trade payoffs. Our evidence also indicates that predictability can be traced to the long legs of the carry trades and their currency components. We test the theoretical restrictions that an asset pricing model, with average currency returns and the mimicking portfolio for the innovations in currency volatility as risk factors, imposes on the coefficients in predictive regressions.     

Regime switches in exchange rate volatility and uncovered interest parity

We use a regime-switching model to examine how exchange rate volatility is related to the failure of uncovered interest parity. Main findings are as follows. First, exchange rate returns are strongly influenced by regime switches in the relationship between the returns and interest rate differentials. Second, low-yielding currencies appreciate less frequently, but once it occurs, their movements are faster than when they depreciate. Third, depreciation of low-yielding currencies and low volatility are mutually dependent on each other. Finally, these three findings are more evident for shorter horizons. The second and third results are consistent with a market participants’ view: short-term carry trades in a low-volatility environment and their rapid unwinding substantially influence exchange rates. We consider the effects of funding liquidity to explain these results.     

Carry Trades and Global Foreign Exchange Volatility

We investigate the relation between global foreign exchange (FX) volatility risk and the cross section of excess returns arising from popular strategies that borrow in low interest rate currencies and invest in high interest rate currencies, so‐called “carry trades.” We find that high interest rate currencies are negatively related to innovations in global FX volatility, and thus deliver low returns in times of unexpected high volatility, when low interest rate currencies provide a hedge by yielding positive returns. Furthermore, we show that volatility risk dominates liquidity risk and our volatility risk proxy also performs well for pricing returns of other portfolios.     

Cross-asset return predictability: Carry trades,stocks and commodities

Equity returns predict carry trade profits from shorting low interest rate currencies. Commodity price changes predict profits from longing high interest rate currencies. The gradual information diffusion hypothesis (Hong & Stein, 1999) provides a ready explanation for these predictability results. These results cannot be explained by time-varying risk premia as stock returns and commodity price changes significantly predict negative carry trade profits. The predictability is one-directional, from commodities to high interest rate currencies, from commodities to stocks and from stocks to low interest rate currencies.     

European Foreign Exchange Risk Exposure

We find that about 13% of our sample of 817 European multinational firms experienced economically significant exposure effects to the Japanese yen, 14% to the US dollar and 22% to the UK pound. Our evidence differs substantially from the US experience and is robust across sub‐sample periods, suggesting that a depreciating (appreciating) euro against foreign currencies has a net negative (positive) impact on European stock returns. Short‐term exposure seems to be relatively well hedged, where considerable evidence of long‐term exposure is found. Firms with weak liquidity positions tend to have smaller exposures. Foreign exposure is found to increase with firm size.     

Liquidity in the Foreign Exchange Market: Measurement,Commonality, and Risk Premiums

We provide the first systematic study of liquidity in the foreign exchange market. We find significant variation in liquidity across exchange rates, substantial illiquidity costs, and strong commonality in liquidity across currencies and with equity and bond markets. Analyzing the impact of liquidity risk on carry trades, we show that funding (investment) currencies offer insurance against (exposure to) liquidity risk. A liquidity risk factor has a strong impact on carry trade returns from 2007 to 2009, suggesting that liquidity risk is priced. We present evidence that liquidity spirals may trigger these findings.     

On financial risk and the safe haven characteristics of Swiss franc exchange rates

We analyse bilateral Swiss franc exchange rate returns in an asset pricing framework to evaluate the Swiss franc's safe haven characteristics. A “safe haven” currency is a currency that offers hedging value against global risk, both on average and in particular in crisis episodes. To explore these issues we estimate the relationship between exchange rate returns and risk factors in augmented UIP regressions, using recently developed econometric methods to account for the possibility that the regression coefficients may be changing over time. Our results highlight that in response to increases in global risk the Swiss franc appreciates against typical carry trade investment currencies such as the Australian dollar, but depreciates against the US dollar, the Yen and the British pound. Thus, the Swiss franc exhibits safehaven characteristics against many, but not all other currencies. We find statistically significant time variation in the relationship between Swiss franc returns and risk factors, with this link becoming stronger in times of stress.     

Does the media help or hurt retail investors during the IPO quiet period?

We examine how the media influences retail trade and market returns during the “quiet period” that follows a firm's IPO. We find that more media coverage during this period is associated with more purchases by retail investors and that such purchases are attention-driven, rather than information-based. Further, these retail trades are negatively associated with stock returns at the firm's first earnings announcement post-IPO. Our results suggest that media coverage, combined with market frictions that limit price efficiency in the post-IPO period, leads to worse investing outcomes for retail investors.     

Currency excess returns and global downside market risk

We assess cross-sectional differences in 23 bilateral currency excess returns in an empirical model that distinguishes between US-specific and global risks, conditional on US bull (upside) or bear (downside) markets. Using the US dollar as numeraire currency, our results suggest that global downside risk is compensated in conditional and unconditional, bilateral currency excess returns. This finding is mostly driven by the emerging markets' currencies in our sample. We also find that the link between the global downside risk and risks associated with a typical carry trade strategy is much weaker for emerging markets' currencies than for developed markets' currencies.     

Are corporate managers savvy about their stock price? Evidence from insider trading after earnings announcements

We find that insiders trade as if they exploit market underreaction to earnings news, buying (selling) after good (bad) earnings announcements when the price reaction to the announcement is low (high). We also find that insider trades attributable to public information about earnings and the price reaction generate abnormal returns. By demonstrating that managers spot market underreaction to earnings news, our results imply that managers are savvy about their company’s stock price.     

THE CHOICE OF TRADING VENUE AND RELATIVE PRICE IMPACT OF INSTITUTIONAL TRADING: ADRs VERSUS THE UNDERLYING SECURITIES IN THEIR LOCAL MARKETS

We address two important themes associated with institutions’ trading in foreign markets: (1) the choice of trading venues (between a company's listing in its home market and that in the United States as an American Depositary Receipt [ADR]) and (2) the comparison of trading costs across the two venues. We identify institutional trading in both venues using proprietary institutional trading data. Overall, our research underscores the intuition that the choice of institutional trading in a stock's local market or as an ADR is a complex process that embodies variables that measure the relative adverse selection and liquidity at order, stock, and country levels. Institutions route a higher percentage of trades to more liquid markets, and these trades are associated with higher cumulative abnormal returns. We also find that institutional trading costs are generally lower for trading cross‐listed stocks on home exchanges even after controlling for selection bias.     

The week-of-the-year effect: Evidence from around the globe

This study investigates another calendar anomaly the literature does not yet address – the week-of-the-year (WOY) effect. Using the weekly returns on the stock market indexes of 20 countries worldwide, for a period that ends in December 2010, the findings demonstrate that returns in Week 44, which starts on October 29 and ends on November 4, are positive in 19 of the 20 countries, and in 18 of them, it is also statistically significant. In contrast, the returns for Week 43, which starts on October 22 and ends on October 28, are negative in 19 of the 20 countries, and statistically significant for most of the countries. We also apply an investment strategy derived from these findings to a prediction period (2009–2010), and find that this strategy beats the simple buy-and-hold policy by a substantial margin.     

Weather and intraday patterns in stock returns and trading activity

We examine the relation between weather in New York City and intraday returns and trading patterns of NYSE stocks. While stock returns are found to be generally lower on cloudier days, cloud cover has a significant influence on stock returns only at the market open. There are significantly more seller-initiated trades when there is more cloud cover at the market open, which is consistent with the return results. Cloudy skies are associated with higher volatility and less market depth over the entire trading day. Finally, cloud cover is not significantly correlated with spread measures and turnover ratios. The findings overall suggest that weather has a significant influence on investors’ intraday trading behavior.     

Systematic consumption risk in currency returns

We sort currencies into portfolios by countries’ past consumption growth. The excess return of the highest- over the lowest-consumption-growth portfolio – our consumption carry factor – compensates for negative returns during world-wide downturns and prices the cross-section of portfolio-sorted and of bilateral currency returns. Empirically, sorting currencies on consumption growth is very similar to sorting currencies on interest rates. We interpret these stylized facts in a habit formation model: sorting currencies on past consumption growth approximates sorting on risk aversion. Low (high) risk-aversion currencies have high (low) interest rates and depreciate (appreciate) in times of global turmoil.     

Institutional stock trading on loan market information

One of the most important developments in the corporate loan market over the past decade has been the growing participation of institutional investors. As lenders, institutional investors routinely receive private information about borrowers. However, most of these investors also trade in public securities. This leads to a controversial question: Do institutional investors use private information acquired in the loan market to trade in public securities? This paper examines the stock trading of institutional investors whose portfolios also hold loans. Using the Securities and Exchange Commission filings of loan amendments, we identify institutional investors with access to private information disclosed during loan amendments. We then look at abnormal returns on subsequent stock trades. We find that institutional participants in loan renegotiations subsequently trade in the stock of the same company and outperform trades by other managers and trades in other stocks by approximately 5.4% in annualized terms.     

Common Stochastic Trends Among Asian Currencies: Evidence for Japan,Aseans, and the Asian Tigers

This study documents that daily changes in Asian exchange rates are significantly non-normal, serially correlated, non-stationary, and have unit roots. Further, accounting for these time series properties and using a longer time horizon than other similar studies of exchange rates, this study also documents cointegration between the Japanese Yen and two sets of Asian currencies, i.e., currencies of the 'Tigers', Hong Kong, South Korea, Singapore, and Taiwan; and currencies of the ASEANs, Malaysia, Philippines, Thailand, and Singapore. These findings of cointegration among Asian exchange rates are in contrast to the findings for the major currencies, and are evidence of nascent Yen blocs in Asia. The results presented here have important implications for understanding Asian financial integration and the international role of the Japanese yen and should be useful for developing asset allocation, currency overlay, value at risk (VAR), and hedging strategies for investments in these often illiquid Asian currencies.     

The effects of oil price shocks on U.S. stock order flow imbalances and stock returns

This paper investigates for the first time the effects of oil demand shocks and oil supply shocks on stock order flow imbalances leading to changes in stock returns. Through the estimation of a structural VAR model, positive oil demand shocks are able to explain almost 36% of the observed variation in the daily average stock order flow imbalances measured by the buy/sell trades ratio; which consequently lead to a negative rather than positive stock returns reaction. In contrast, oil supply shocks exhibit a negative and marginally significant effect on stock order flow imbalances. Our aggregate analysis suggests that positive shocks on stock order flow imbalances are negatively related to stock returns. These effects are stronger for oil-related sectors when compared with the rest of the equities sectors.     

Pricing currency risk in the stock market: Evidence from Finland and Sweden 1970-2009

We investigate the role of currency risk on stock markets in two interlinked Nordic countries exhibiting a gradual move from fixed to floating exchange rates. We apply the Ding and Engle (2001) covariance stationary specification in a multivariate GARCH-M setup to test a conditional international asset pricing model. Using a sample period from 1970 to 2009, we find that the currency risk is priced in both stock markets, and that the price and the risk premium are lower after the floatation of the currencies, especially for Finland. We also find the cross-country exchange rate shock from Finland to affect the price of currency risk in Sweden, but not vice versa. Finally, we discuss some of the potential issues in applying multivariate GARCH-M specifications in tests of asset pricing models.