Predicting exchange rate returns

We test whether forward premiums predict spot exchange rate returns for 16 currencies. We apply a recently developed time series predictability test that allows us to model data features including heteroskedasticity in forward premium. We discover return predictability for 75% (12/16) of currencies in our sample. Trading strategies show that investors can make more profits from our proposed forward premium model compared to a random walk model and foreign exchange carry trade model.     

The relationship between currency carry trades and U.S. stocks

The article examines the relationship between daily returns of currency carry trades and U.S. stocks from January 1995 through September 2010. Carry trade and stock returns are highly correlated with no Granger‐causality in either direction. An EGARCH model shows that significant volatility spillovers flow from the stock market to the carry‐trade market, but not vice versa. The markets are more correlated in periods of high volatility. Volatilities in both markets also increase more with negative innovations than positive innovations. A sectoral analysis of the index suggests that volatilities of cyclical stocks have more impact than noncyclical stocks on carry trades.     

The carry trade and fundamentals: Nothing to fear but FEER itself

Risky arbitraging based on interest rate differentials between two countries is typically referred to as a carry trade. Up until the recent global financial crisis, these trades generated years of persistent positive returns, which were hard to reconcile with standard pricing kernels. In 2008 these trades blew up, which seemed to weaken the case for a puzzle relating to predictable currency returns. But the rise and fall of this puzzle in the academic literature has only been concerned with naïve carry trades based on yield signals alone. We show, however, that some simple and more realistic fundamentals-augmented trading strategies would have generated strong and sustained positive profits that endured through the turmoil.     

FX Market Returns and Their Relationship to Investor Fear

This note examines the relationship between changes in levels of investor fear (measured by the implied volatility index) and foreign exchange market returns. Our empirical results indicate a negative relationship between daily returns on high‐interest rate (investing) currencies and changes in the implied volatility index, while the association is positive for low‐interest rate (funding) currencies. That is, investing (funding) currencies tends to depreciate (appreciate) when investor fear increases. A sequential breakpoint test identifies a significant change in this relationship in the period following the 2008 collapse of Lehman Brothers, and another in 2012 following the resolution of the European sovereign debt crisis, which suggests that the relationship is linked to financial system liquidity. During the crisis period, currency returns are much more sensitive to changes in investor fear, and this is particularly so for funding currencies that are perceived to present a safe‐haven. The results have important implications for international finance, and those looking to speculate via the carry trade.     

Commodity Price,Carry Trade,and the Volatility and Liquidity of Asian Currencies

This study examines how the volatility and liquidity of 10 Asian exchange rates against the US dollar change with volatilities in commodity price and carry trade over the period of January 2000 to June 2010. We find that uncertainties in commodity markets and carry trades are significantly correlated with the volatilities and the bid‐ask spreads of most Asian currencies. The correlation with carry trade is generally stronger and has been rising over the sample period. While high volatilities in carry trade are associated with high volatilities in many Asian currencies, high volatilities in commodity price do not coincide with excessive volatilities in Asian currencies. This suggests that investors and policymakers should be more concerned with the volatility in carry trade.     

Industry relatedness in trade sales and venture capital investment returns

We investigate relationships between the industry relatedness of venture capital-backed companies and their strategic acquirer in trade sales and the achieved investment returns of venture capitalists. Using a proprietary data set of 716 trade sales, we analyze return differences between lateral and synergetic trade sales, as well as between horizontal and vertical trade sales. We find that venture capitalists achieve higher returns with lateral rather than synergetic trade sales, and that the difference is greater for deals involving early stage companies characterized by strong information asymmetries. In addition, horizontal trade sales yield higher returns than vertical trade sales; however, in boom phases of the venture capital market, this effect reverses. Finally, we find that experienced venture capitalists are able to overcome disadvantageous situations in trade sales, resulting in comparable returns across all trade sale categories.     

Variance and skew risk premiums for the volatility market: The VIX evidence

We extract variance and skew risk premiums from volatility derivatives in a model-free way and analyze their relationships along with volatility index and equity index returns. These risk premiums can be synthesized through option trading strategies. Using a time series of option prices on the VIX, we find that variance swap excess return can be partially explained by volatility index and equity index excess returns while these latter variables carry little information for the skew swap excess return. The results sharply contrast with those obtained for the equity index option market underlining very specific characteristics of the volatility derivative market.     

Volatility,global information,and market conditions: a study in futures markets

This study examined the behavior of return volatility in relation to the timing of information flow under different market conditions influenced by trading volume and market depth. We emphasized information flow during trading and nontrading periods that may represent domestic and offshore information in the global trading of currencies. Test results show that volatility was negatively related to market depth; that is, deeper markets had relatively less return volatility. Additionally, the effect that market depth had on volatility was superseded by information within trading volume. Test results focusing on the timing of information flow reveal that in low‐volume markets, the volatility of nontrading‐period returns exceeded the volatility of trading‐period returns. However, when trading volume was high, this pattern was reversed and conformed to the observations of earlier articles. Our findings proved to be robust across time, different currency markets, and different measures of return volatility. We also observed a trend toward greater integration between foreign and U.S. financial markets; the U.S. market increasingly emphasized information from nontrading periods to supplement information arriving during trading periods. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:173–196, 2001     

Subjective Probability Density Functions from FX Option Prices: Predictive Power and Performance on a Carry Trade Strategy

In this article, we extracted the risk‐neutral densities (RNDs) and subjective probability density functions of the US Dollar/Brazilian Real (USD/BRL) exchange rate and evaluated its performance in predicting the future realizations of the USD/BRL exchange rate. The RNDs were estimated using two structural models and three nonstructural models. In the first category, we included the Variance Gamma‐OU model and the CGMY Gamma‐OU model. In the second category, we included the density functional based on confluent hypergeometric function model, the mixture of lognormal distributions model, and the smoothed implied volatility smile. The density functional based on confluent hypergeometric function and the CGMY Gamma‐OU produced 1‐month term densities (RND and subjective probability density function) with the highest forecasting power of the 1‐month USD/BRL exchange rate. Finally, we applied the CGMY Gamma‐OU model to extract a sample of subjective cumulative probabilities of 1‐month USD/BRL movements, and used them as explanatory variables in predictive time series models, whose dependent variable was the 1‐month carry trade return. Its predictive power was then tested and confirmed in three trading strategies that over performed the standard carry trade strategy in terms of annualized cumulative returns.     

The market response of insider transferring trades and firm characteristics in Taiwan

This paper reports the announcement effects of insider transfer trades and relates these with firms' characteristics. Regulations in Taiwan specify that insiders give three days prior notice to the competent authority of stock transfers and this news can stimulate market participants' investment decisions. We find both the positive and negative abnormal returns exist following insider transfer trade announcements, especially for smaller firm. However, smaller firm sizes associate with larger magnitudes of negative abnormal returns. Furthermore, the connection between smaller firms and those with higher book-to-market ratios strengthens for larger negative abnormal returns.     

Option and Futures Evaluation With Deterministic Volatilities1

Several risk-neutral expectation formulae are derived in a general multifactor setting. Specializing to deterministic covariances of returns, they lead to formulae for forward and future prices as well as formulae for options on forward and futures contracts. the results are applicable to currencies, bonds, commodities with stochastic convenience yield, and stock indices. For currencies, a noarbitrage relation between domestic and foreign economies is formulated and applied to evaluate quanto futures and options.     

Do tax-exempt yields adjust slowly to substantial changes in taxable yields?

This paper examines the profitability of two futures trading strategies: a municipal bond futures contract strategy and a spread strategy consisting of a municipal bond futures contract and a Treasury bond futures contract. Both strategies are designed to exploit a slow municipal yield adjustment following changes in Treasury yields. We find economically significant profits to both strategies. Average holding period returns per trade for both strategies tend to increase with the magnitude of the Treasury yield change. Profit distributions associated with various Treasury yield change thresholds tend to be positively skewed, and median profits are significantly lower than average profits. The profitability results are consistent with slow municipal yield adjustments. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:763–789, 2008     

Interdependence of Major Exchange Rates in Ghana: A Wavelet Coherence Analysis

ABSTRACT

We have employed the three-dimensional continuous Morlet wavelet transform methodology to explore the co-movement amongst the returns of four major currencies in Ghana (dollar, euro, pound, and yen) for the period May 1999 to February 2018. The analysis reveals that the dynamics of the interdependence of the currencies is time-varying and heterogeneous. Our empirical findings demonstrate that the currencies are closely linked or interconnected. The lead–lag relationships between the returns of the exchange rates established that volatilities in the euro and yen significantly affect movements in the other currencies in daily and weekly exchange rate returns. The presence of lead–lag effects and stronger co-movements at short-run fluctuations may induce arbitrage and diversification opportunities to investors, albeit with limited space. The differences in the co-movements of returns and the evidence of contagion among the foreign exchange markets provide reliable incentive to the monetary authorities for unflinching strides to halt the speeding exchange rates.     

Intraday return predictability,portfolio maximisation,and hedging

We examine whether intraday Chinese return predictability is linked to optimal portfolio holding and hedging. We find that: (1) S&P500 futures returns only predict Chinese spot market returns in up to 5-minute of trading with predictability disappearing at higher frequencies of trade; (2) the portfolio weight is maximised at the 5-minute trading frequency, when predictability is the strongest; and (3) when predictability is the strongest, significantly less shorting of the futures is required to minimise risk when a long position is taken in the Chinese market.     

Yield curve risks in currency carry forwards

We provide empirical evidence that cross-country yield curve gaps (parallel gap, twist gap, and butterfly gap) are predictive to the expected currency carry premiums using currency forward contracts. We find that the expected currency gains are more notable as these yield curve risk factors at time t indicate short-term bond prices of investment currencies to go up (positive parallel movement, negative twist, and positive butterfly). We also find carry gains are more sensitively affected by cross-country monetary shocks than currency-country inflation pressures and business cycles. Our findings support that cross-country yield curve risk premiums still exist even after considering transaction costs.     

Technology-investing countries and stock return predictability

For 77 technology-investing countries we test whether their stock market returns are predictable. We find that exchange rate returns and U.S. stock excess returns predict stock market returns for most countries in our sample, while crude oil and inflation predict returns of less than 40% of countries. While in out-of-sample tests the evidence of predictability declines, U.S. returns still beat the constant returns model for three-quarters of countries in our sample. A portfolio of all 77 countries offers a mean-variance investor annualized profits of between 5.7% and 8.0%, and profits are maximized when return forecasts are based on U.S. returns.     

Fair trades by trade fairs: Information providing institutions under monopolistic competition

It is a standard result of search theory that the optimal reservation supply price, e.g. wage, is negatively correlated to search costs. This paper applies the inverse relationship, between demand prices and limit prices, to the analysis of an hitherto unexplored topic: trade fairs. Trade fairs bloomed during the Middle Ages and early trade-based capitalism and survived for centuries. In last decades, their growth became sustained: they attract every year hundreds of thousands of exhibitors and tens of millions of visitors.The driving forces behind the trade fair activity are increasing return to scale of search for information, under conditions of imperfect competition, particularly large group monopolistic competition. Under these circumstances, trade fairs offer their participants a collective substitute for information activities that would be beyond individual possibilities. This mechanism is of paramount importance for small firms. Where there are many small suppliers and buyers, and product differentiation, trade fairs give agents the opportunity of low-cost, high-density information exchanges, under spacetime constraints. This leads to lower search costs and lower limit prices, then fairer trades. But this mechanism also implies natural monopoly or oligopoly: the larger the trade fair, i.e. the larger the number of suppliers and visitors who participate, the less the average cost of the service. More generally, natural monopolies arising from decreasing-to-scale search costs ask for a new view of government's role either in the organization or in the regulation of information exchanges. Policy implications for small business development are stressed, including tariff regulation, public investment, and involvement of small business associations in the design and organization of trade fairs.     

Risk–return relationships in foreign‐currency futures following macroeconomic announcements

This study uses the tick data for foreign‐currency futures to examine risk–return relationships on macroeconomic announcements. This study—different from previous studies—examines the risk–return relationship by capturing the announcement effect on returns with announcement surprises and on volatilities with announcement dummies simultaneously in a Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model. Strong risk–return relationships are detected for the first min after the announcements. Furthermore, the return–risk tradeoff ratios differ across currencies and across macroeconomic indicators. The same information can be more profitable when acted on the more liquid currency futures. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22: 729–764, 2002     

Evidence on the dynamic relationship between international trade and the stock market

This study uses vector autoregressive analysis to examine the dynamic interactions of monthly real stock returns, return volatility, exchange rates, export growth and import growth for Hong Kong, Korea, Singapore, and Taiwan for the period 1975–91. We find that exports and imports have significant interactions. The results also indicate that stock returns in Hong Kong and Singapore Granger-cause trade flows. Return volatility is found to react strongly to trade news in all four countries, a result supporting the efficient-market hypothesis.     

High-Frequency Price Discovery and Price Efficiency on Interest Rate Futures

This paper estimates a collection of high-frequency informational efficiency metrics by constructing a unique Eurodollar futures data set with the complete messaging history. To capture price efficiency, this paper calculates the mid-quote return autocorrelations following a full range of time intervals. The findings suggest the mid-quote return autocorrelations are positive and gradually increase from the tick-level to 30-min. Then, I utilize a vector autoregression to estimate the pricing error, which shows the adjustment time of trade returns is completed in 1 s. Furthermore, trade prices are less sensitive about incorporating any available new information as the Eurodollar futures approaches its maturity.