Price clustering in foreign exchange spot markets

This paper documents the existence of price clustering in the foreign exchange spot market for the German mark, the Japanese yen, the United Kingdom pound, the French franc, the Italian lira, and the Swedish krona. The U.S. dollar exchange rate indicative quotes for these currencies tend to exhibit clustering around right-most digits that end in either a “zero” or a “five.” The tendency for exchange rates to cluster has increased with increases in trading volume and volatility. Moreover, the tendency for exchange rates to cluster differs across currencies.     

FOREIGN-CURRENCY OPTIONS, EX ANTE EXCHANGE-RATE VOLATILITY, AND MARKET EFFICIENCY: AN EMPIRICAL TEST

“The currency option's attraction results from the volatility of foreign-exchange markets, where rates can move as much as 3 percent in a day” (M. Sesit, Wall Street Journal, April 20, 1984, p. 25). This study compares the foreign-exchange rate implicit volatility of call options and put options that are written on a foreign currency. These implicit volatilities should be equal, and equal to the volatility of the proportional change in the exchange rate, given that option prices are efficient and that the foreign-currency option pricing model described by Biger and Hull holds. The foreign-currency options that are examined in this study are the British pound, Canadian dollar, Japanese yen, Swiss franc, and West German mark. The results of this study support the notions of market efficiency and put-call parity.     

The Forward Exchange Rate Bias Puzzle Is Persistent: Evidence from Stochastic and Nonparametric Cointegration Tests

An important puzzle in international finance is the failure of the forward exchange rate to be a rational forecast of the future spot rate. We document that even after accounting for nonstationarity, nonnormality, and heteroskedasticity using parametric and nonparametric tests on data for over a quarter century, U.S. dollar forward rates for the major currencies (the British pound, Japanese yen, Swiss franc, and the German mark) are generally not rational forecasts of future spot rates. These findings deepen the forward exchange rate bias puzzle, especially as these markets are the most liquid foreign exchange markets with very low trading costs.     

Can Affine Term Structure Models Help Us Predict Exchange Rates?

This paper proposes an arbitrage-free model to extract the information that the term structure of forward premia contains for forecasting future spot exchange rates. Using monthly data on four U.S. dollar bilateral exchange rates, we find evidence that this model provides statistically better forecasts than those produced by a random walk for the British pound and Canadian dollar exchange rates. Negative results for the German mark/Euro and Swiss franc are explained by a rejection of the restrictions imposed by the term structure model.     

R/S analysis of foreign exchange rates under two international monetary regimes

The purpose of this study is to examine empirically the behavior of foreign exchange markets during the most recent experiences with fixed and flexible rates. Specifically, this study explores the possibility that long-term dependence is present in the exchange rate series for the British pound, French franc, and German mark in terms of the U.S. dollar. Using R/S analysis, positive long-term dependence is uncovered for each exchange rate during the flexible regime but negative dependence is found in the fixed period.     

THE HEDGING EFFECTIVENESS OF FOREIGN CURRENCY FUTURES

This study provides an initial analysis of the hedging potential of the foreign currency futures markets. Numerous studies exist on the pricing efficiency and hedging effectiveness of the foreign currency forward markets, but little research exists on the foreign currency futures market. An adequate price history has only recently become available to carry out such an investigation. Minimum risk hedges and hedging effectiveness measures are presented for five currencies: the British pound, German mark, Canadian dollar, Japanese yen and Swiss franc. Analysis indicates the relative desirability of positions in futures contracts to minimize the risk of spot currency exposure. Results also show hedging effectiveness increases with the investment horizon.     

The high-frequency response of exchange rates to monetary policy actions and statements

This paper investigates the impact of US monetary policy on the level and volatility of exchange rates using an event study with intraday data for five currencies (the US dollar exchange rate versus the euro, the Canadian dollar, the British pound, the Swiss franc, and the Japanese yen). I construct two indicators of news about monetary policy stemming separately from policy decisions and from balance of risk statements. Estimation results show that both policy decisions and communication have economically large and highly significant effects on the exchange rates, with the surprise component of statements accounting for most of the explainable variation in exchange rate returns in response to monetary policy. This paper also shows that exchange rates tend to absorb FOMC monetary surprises within 30-40 min from the announcement release.     

Random walk and monetary causality in five exchange markets

Time series behavior of monthly spot exchange rates for the French franc, the Deutsche mark, the Italian lira, the Japanese yen, and the UK pound, all priced in relation to the US dollar, shows the robustness of the random walk hypothesis. Incremental efficiency is investigated by a new test procedure, based on the reduction of the forecast error variance, which is a direct implementation of the definition of Granger causality. Exchange markets are found to be not only money efficient, but also monetary efficient in that they are efficient with respect to real income and market interest rates in addition to money stock.     

Implied volatility linkages among major European currencies

This paper examines linkages in expected future volatilities among major European currencies. For that purpose, volatility expectations implied by currency options on the euro, British pound, and Swiss franc quoted against the U.S. dollar are analysed. Vector autoregressive modelling is applied to ascertain the dynamics of the implied volatilities across currencies. The results show that the market expectations of future exchange rate volatilities are closely linked among major European currencies. Furthermore, it is found that the implied volatility of the euro significantly affects the volatility expectations of the British pound and the Swiss franc.     

Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options

This article tests the expectations hypothesis in the term structure of volatilities in foreign exchange options. In particular, it addresses whether long-dated volatility quotes are consistent with expected future short-dated volatility quotes, assuming rational expectations. For options observed daily from December 1, 1989 to August 31, 1992 on dollar exchange rates against the pound, mark, yen, and Swiss franc, we are unable to reject the expectations hypothesis in the great majority of cases. The current spread between long- and short-dated volatility rates proves to be a significant predictor of the direction of future short-dated rates.     

The Asymmetric Impact of Monetary Policy on Currency Markets

This study examines whether tightening and easing actions of the Federal Reserve symmetrically influence currency markets. Using daily data on four exchange rates from 1989 to 2001, we find that changes in the Fed's interest rate target are positively related to changes in the value of the dollar. Surprises associated with monetary tightening have a larger announcement effect as compared to monetary easing for the British pound, German mark, and Canadian dollar, whereas the opposite is true for the Japanese yen. The results appear to be driven by the reactions of foreign central banks to Fed actions, the Fed's credibility as a policymaker, and by the change in the Fed's disclosure policy beginning in 1994.     

FX Dynamics,Limited Participation,and the Forward Bias Anomaly

Standard foreign exchange (FX) models with goods price stickiness and instantaneous asset market adjustments imply FX overshooting ( Dornbusch, 1976 ), which can explain the forward bias anomaly. Lyons (2001) explained the anomaly via limited participation of FX speculators due to Sharpe ratios lower than equity market alternatives, which implies FX undershooting to interest differential shocks. I derive the time‐series implications of overshooting and undershooting for the joint forward/spot FX dynamics in a vector error correction model. I use generalized impulse response analysis ( Pesaran and Shin, 1998 ) to test those implications. All FX studied (pound, deutsch mark, French franc, yen, and Canadian dollar) have dynamics consistent with undershooting during the period from 1975 to 1998.     

Paramater estimation bias and volatility scaling in Black-Scholes option prices

When asset returns conform to a Gaussian distribution, the moments of the distribution over long return intervals may be estimated by scaling the moments of shorter return intervals. While it is well known that asset returns are not normally distributed, a key empirical question concerns the effect that scaling the volatility of dependent processes will have on the pricing of related financial assets. This study investigates the return properties of the most important currencies traded in spot markets against the U.S. dollar: the Japanese yen, the British pound, and the Swiss franc during the period November 1983 to April 2004. The novelty of this paper is that the volatility properties of the series are tested utilising statistical procedures developed from fractal geometry, with the economic impact determined within an option-pricing framework.     

Forecasting currency prices using a genetically evolved neural network architecture

In this paper, a hybrid system combining neural networks and genetic training is designed to forecast the three-month spot rate of exchange for four currencies: the British pound, the German mark, the Japanese yen, and the Swiss franc. The networks' forecasts are compared to the predictions made by the forward and futures rates, and are evaluated based on their degree of accuracy and their ability to correctly forecast the direction of the change in the exchange rate movement.     

Testing for volatility spillover between the British pound and the euro

This paper examines volatility spillover between two nominal U.S. dollar exchange rates: the British pound and the euro. Using the residual cross-correlation approach, we observe that the euro Granger-causes the British pound in variance, whereas the British pound does not Granger-cause the euro in variance. Our findings support unidirectional volatility spillover from the euro to the British pound; thus, the euro volatility has a one-sided impact on the British pound volatility. Moreover, the findings suggest that euro traders succeed in the efficient processing of information derived from the British pound.     

Higher Moments and Exchange Rate Behavior

This paper uses 15‐minute exchange rate returns data for the six most liquid currencies (i.e., the Australian dollar, British pound, Canadian dollar, Euro, Japanese yen, and Swiss franc) vis‐à‐vis the United States dollar to examine whether a GARCH model augmented with higher moments (HM‐GARCH) performs better than a traditional GARCH (TG) model. Two findings are unraveled. First, the inclusion of odd/even moments in modeling the return/variance improves the statistical performance of the HM‐GARCH model. Second, trading strategies that extract buy and sell trading signals based on exchange rate forecasts from HM‐GARCH models are more profitable than those that depend on TG models.     

Forecasting foreign exchange rates using idiosyncratic volatility

Average idiosyncratic stock volatility forecasts the bilateral exchange rates of the US dollar against major foreign currencies in and out of sample. The US dollar tends to appreciate after an increase in US idiosyncratic volatility. Similarly, ceteris paribus, German and Japanese idiosyncratic volatilities positively and significantly correlate with future US dollar prices of the Deutsche mark and the Japanese yen, respectively. Our results suggest that exchange rates are predictable.     

Nonlinear dynamics in foreign exchange excess returns: Tests of asymmetry

This paper examines the nonlinear dynamic behaviors in foreign exchange excess returns of eight currencies. We applied the BDS test and two other nonlinear statistical techniques, the Markov chain, and time reversibility tests to characterize the exchange rate returns dynamics. The results from the BDS test provide strong evidence of nonlinear dependence on the British pound, the Singapore dollar, the South African rand, and the Swedish krone. The Markov chain test shows evidence of a non-random walk and positive serial dependence in all currencies except for the British pound, the Canadian dollar, and the Swiss franc. Lastly, evidence of time irreversible and asymmetric dynamic behavior is found in seven currencies with the exception of the Canadian dollar. The results indicate that the asymmetry in the Singapore dollar, the South African rand, and the Swiss franc is due to nonlinearity in the functional form as opposed to non-Gaussian innovations.     

European foreign exchange market efficiency: Evidence based on crisis and noncrisis periods

This study investigates the impact on foreign exchange market efficiency of the 1992 European financial market crisis by studying precrisis, crisis, and postcrisis periods. Long-term relationships among European currency values are identified during the three periods, although the relationships are not stable during the precrisis and the postcrisis periods. These results may be due to one or more of the following: (1) market inefficiency, (2) a risk premium, or (3) common policy guidelines for European monetary system (EMS) members. Evidence of market inefficiency is strong. Forecasting results demonstrate better performance by an error correction model (ECM) than by a random walk model (RWM) for the British pound and German mark, while results for the French franc and Italian lira are mixed. Dominance tests using Granger causality indicate only weak German mark dominance both in the short and long run.