Showing papers on "Foreign exchange market published in 2009"
TL;DR: This article studied the impact of algorithmic trading in the foreign exchange market using a long time series of high-frequency data that identify computer-generated trading activity and found that the reduction in arbitrage opportunities is associated primarily with computers taking liquidity.
Abstract: We study the impact of algorithmic trading (AT) in the foreign exchange market using a long time series of high-frequency data that identify computer-generated trading activity. We find that AT causes an improvement in two measures of price efficiency: the frequency of triangular arbitrage opportunities and the autocorrelation of high-frequency returns. We show that the reduction in arbitrage opportunities is associated primarily with computers taking liquidity. This result is consistent with the view that AT improves informational efficiency by speeding up price discovery, but that it may also impose higher adverse selection costs on slower traders. In contrast, the reduction in the autocorrelation of returns owes more to the algorithmic provision of liquidity. We also find evidence consistent with the strategies of algorithmic traders being highly correlated. This correlation, however, does not appear to cause a degradation in market quality, at least not on average.
407 citations
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TL;DR: In this article, an implementable financial stress index (FSI) is created and then used to illustrate the dramatic nature of the current crisis compared to earlier crises and how the global FSI might have been used to condition the exposure to the carry trade.
Abstract: The financial crisis of 2007-2008 had major implications for the foreign exchange market. We review events and implications for exchange rates, volatility, returns to currency investing, and transaction costs. This “blow-by-blow” narrative is intended to be a resource for researchers seeking a comprehensive review of the “what, why and when” of the financial crisis in terms of foreign exchange market dynamics. An implementable financial stress index (FSI) is created and then used to illustrate the dramatic nature of the current crisis compared to earlier crises. We also examine how the global FSI might have been used to condition the exposure to the carry trade (long high interest rate currencies, short low interest rate currencies) and we show that such an index has potential value in protecting a portfolio against loss during periods of stress, although this result is subject to the important caveats of controlling for transaction costs and timely recognition of the change in regime.
384 citations
TL;DR: In this paper, the authors analyze the intertemporal stability of returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously published rules.
Abstract: We analyze the intertemporal stability of returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously published rules. The excess returns of the 1970s and 1980s were genuine and not just the result of data mining. But these profit opportunities had disappeared by the mid-1990s for filter and moving average (MA) rules. Returns to less-studied rules, such as channel, ARIMA, genetic programming and Markov rules, also have declined, but have probably not completely disappeared. The volatility of returns makes it difficult to estimate mean returns precisely. The most likely time for a structural break in the MA and filter rule returns is the early 1990s. These regularities are consistent with the Adaptive Markets Hypothesis (Lo, 2004), but not with the Efficient Markets Hypothesis.
213 citations
TL;DR: In this paper, the authors analyze the intertemporal stability of excess returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously studied rules.
Abstract: We analyze the intertemporal stability of excess returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously studied rules. The excess returns of the 1970s and 1980s were genuine and not just the result of data mining. But these profit opportunities had disappeared by the early 1990s for filter and moving average rules. Returns to less-studied rules also have declined but have probably not completely disappeared. High volatility prevents precise estimation of mean returns. These regularities are consistent with the Adaptive Markets Hypothesis (Lo (2004)), but not with the Efficient Markets Hypothesis.
197 citations
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13 Jan 2009
TL;DR: In this paper, a game server receives financial data on market conditions (such as currency markets) from a financial server and regularly synchronizes user's game environments to match the financial data, and can initiate the opening and closing of positions in the financial market based on players' game behavior.
Abstract: A network-based computer game that both uses real-time financial data to affect game state and uses participants' actions to determine and engage in financial transactions. A game server receives financial data on market conditions (such as currency markets) from a financial server and regularly synchronizes user's game environments to match the financial data. The game server propagates financial data to the game or games, coordinates communication (if any) between the games, and can initiate the opening and closing of positions in the financial market based on players' game behavior. The financial market can be a currency market, where one nation's currency can be exchanged for another currency at a certain exchange rate.
161 citations
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TL;DR: The Lehman Brothers failure stressed global interbank and foreign exchange markets because it led to a run on money market funds, the largest suppliers of dollar funding to non-US banks.
Abstract: The Lehman Brothers failure stressed global interbank and foreign exchange markets because it led to a run on money market funds, the largest suppliers of dollar funding to non-US banks. Policy stopped the run and replaced private with public funding.
157 citations
TL;DR: The authors provide an overview of the important events of the recent global financial crisis and their implications for exchange rates and market dynamics, and construct a quantitative measure of crises that allows for a comparison of the current crisis to earlier events, and address whether one could have predicted costly events before they happened in a manner that would have allowed market participants to moderate their risk exposures and yield better returns from currency speculation.
139 citations
TL;DR: In this paper, the authors investigated the link between the predictability of excess returns and expectational errors in a much broader set of financial markets, using data on survey expectations of market participants in the stock market, the foreign exchange market, a bond market and money markets in various countries.
136 citations
TL;DR: This paper argued that overvaluation can thwart development through an attack of Dutch disease, and discussed the role that exchange rate policy may play in avoiding this outcome, but the behavioral model of the exchange rate implies that intervention can also play a role.
Abstract: Much of the paper is devoted to expounding the standard model of the exchange rate accepted by most economists today. This regards the exchange rate as a forward-looking asset price. Its steady-state level is determined by the need to have a current account balance that will keep the debt/gross domestic product (GDP) ratio constant, while the path of adjustment toward this steady-state level is determined by the representative agent's rational expectation of what will happen between now and the long run. The paper then examines a number of criticisms of this model: that exchange rate changes are driven by 'news' and will be nonexistent in the absence of news; that it implies that chartist rules will systematically lose money; and that it leaves no room for 'bubble-and-crash' dynamics, which appear to have occurred. An alternative 'behavioral' model that gives room for such behavior is presented. The paper then argues that overvaluation can thwart development through an attack of 'Dutch disease,' and discusses the role that exchange rate policy may play in avoiding this outcome. This demands primarily the use of nonmonetary instruments like fiscal policy or capital controls, but the behavioral model of the exchange rate implies that intervention can also play a role. The paper also includes a discussion of the alternative exchange-rate regimes available.
129 citations
TL;DR: This paper showed that carry trade is significantly profitable for most currency pairs and portfolios and that positive returns do not diminish in time providing a strong case against the hypothesis of uncovered interest rate parity.
Abstract: Studying all possible pairs of 11 major currencies and 11 portfolios in 1976–2008 we show that, when there is no leverage, carry trade is significantly profitable for most currency pairs and portfolios. Positive returns do not diminish in time providing a strong case against the hypothesis of uncovered interest rate parity. We explain these findings with the leveraged nature of carry trade: leverage may increase profitability but it materially increases downside risk. We argue that market inefficiency is related to the level of leverage.
124 citations
TL;DR: This work employs a node-centric approach that allows it to track the effects of the community evolution on the functional roles of individual nodes without having to track entire communities, and finds that exchange rates that are strongly attached to their community are persistently grouped with the same set of rates.
Abstract: We study the cluster dynamics of multichannel (multivariate) time series by representing their correlations as time-dependent networks and investigating the evolution of network communities. We employ a node-centric approach that allows us to track the effects of the community evolution on the functional roles of individual nodes without having to track entire communities. As an example, we consider a foreign exchange market network in which each node represents an exchange rate and each edge represents a time-dependent correlation between the rates. We study the period 2005–2008, which includes the recent credit and liquidity crisis. Using community detection, we find that exchange rates that are strongly attached to their community are persistently grouped with the same set of rates, whereas exchange rates that are important for the transfer of information tend to be positioned on the edges of communities. Our analysis successfully uncovers major trading changes that occurred in the market during the credit crisis.
TL;DR: In this paper, the adverse selection problem facing market makers is worse when an agent wants to trade against a public information signal, and there is more adverse selection associated with a sell order than with a buy order.
Abstract: High interest rate currencies tend to appreciate relative to low interest rate currencies We argue that adverse selection problems between participants in foreign exchange markets can account for this "forward premium puzzle" The key feature of our model is that the adverse selection problem facing market makers is worse when an agent wants to trade against a public information signal So, when based on public information, the currency is expected to appreciate, there is more adverse selection associated with a sell order than with a buy order
TL;DR: In this paper, the authors investigated the contribution of the spot market to the price discovery of Euro and Japanese Yen exchange rates in three foreign exchange markets based on electronic trading systems: the CME GLOBEX regular futures, E-mini futures, and the EBS interdealer spot market.
Abstract: Using intraday data, this study investigates the contribution to the price discovery of Euro and Japanese Yen exchange rates in three foreign exchange markets based on electronic trading systems: the CME GLOBEX regular futures, E-mini futures, and the EBS interdealer spot market. Contrary to evidence in equity markets and more recent evidence in foreign exchange markets, the spot market is found to consistently lead the price discovery process for both currencies during the sample period. Furthermore, E-mini futures do not contribute more to the price discovery than the electronically traded regular futures. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 29:137–156, 2009
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TL;DR: In this article, an implementable financial stress index (FSI) is created and then used to illustrate the dramatic nature of the current crisis compared to earlier crises and how the global FSI might have been used to condition the exposure to the carry trade.
Abstract: The financial crisis of 2007-2008 had major implications for the foreign exchange market. We review events and implications for exchange rates, volatility, returns to currency investing, and transaction costs. This “blow-by-blow” narrative is intended to be a resource for researchers seeking a comprehensive review of the “what, why and when” of the financial crisis in terms of foreign exchange market dynamics. An implementable financial stress index (FSI) is created and then used to illustrate the dramatic nature of the current crisis compared to earlier crises. We also examine how the global FSI might have been used to condition the exposure to the carry trade (long high interest rate currencies, short low interest rate currencies) and we show that such an index has potential value in protecting a portfolio against loss during periods of stress, although this result is subject to the important caveats of controlling for transaction costs and timely recognition of the change in regime.
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TL;DR: In this paper, the authors examine evidence of systematic patterns in exchange rate movements on MPC days over the first decade of operation of the MPC and find evidence for non-linear regime switching between a high-volatility, informed-trading state and a low-volatile, liquidity-transition state.
Abstract: Since 1997, the Bank of England Monetary Policy Committee (MPC) has met monthly to set the UK policy interest rate. We examine evidence of systematic patterns in exchange rate movements on MPC days over the first decade of operation of the MPC. Daily data reveal significant differences in volatility on the last of three meeting days when the interest rate announcement surprises the market. Intraday, five-minute return data are then used to provide a microscopic view. We use a Markov-switching framework that incorporates endogenous transition probabilities, which allows for an interesting alternative characterization of macroeconomic news effects on the foreign exchange market. We find evidence for non-linear regime switching between a high-volatility, informed-trading state and a low-volatility, liquidity-trading state. MPC surprise announcements are shown significantly to affect the probability that the market enters and remains within the informed trading regime, with some limited market positioning just prior to the announcement.
TL;DR: In this paper, the authors analyzed the structure of the world foreign currency exchange market viewed as a network of interacting currencies and analyzed the temporal evolution of the network and detect that its structure is not stable over time.
Abstract: We analyse structure of the world foreign currency exchange (FX) market viewed as a network of interacting currencies. We analyse daily time series of FX data for a set of 63 currencies, including gold, silver and platinum. We group together all the exchange rates with a common base currency and study each group separately. By applying the methods of filtered correlation matrix we identify clusters of closely related currencies. The clusters are formed typically according to the economical and geographical factors. We also study topology of weighted minimal spanning trees for different network representations (i.e., for different base currencies) and find that in a majority of representations the network has a hierarchical scale-free structure. In addition, we analyse the temporal evolution of the network and detect that its structure is not stable over time. A medium-term trend can be identified which affects the USD node by decreasing its centrality. Our analysis shows also an increasing role of euro in the world’s currency market.
TL;DR: The authors explored the role of exchange rates in emerging economies with inflation-targeting regimes, an issue that has become especially germane during the current episode of financial turmoil and volatile capital flows.
Abstract: This paper explores the role of exchange rates in emerging economies with inflation-targeting regimes, an issue that has become especially germane during the current episode of financial turmoil and volatile capital flows. Under inflation targeting, the interest rate is the main monetary policy tool for influencing activity and inflation, and there is little agreement about the appropriate role of the exchange rate. The exchange rate is a more important monetary policy tool for emerging economies that have adopted inflation targeting than it is for inflation-targeting advanced economies. Inflation-targeting emerging economies generally have less flexible exchange rate arrangements and intervene more frequently in the foreign exchange market than their advanced economy counterparts. The enhanced role of the exchange rate reflects these economies' greater vulnerability to exchange rate shocks and their less developed financial markets. However, their sharper focus on the exchange rate may cause some confusion about the commitment of their central banks to achieve the inflation target and may also complicate policy implementation. Global inflation pressures, greater exchange rate volatility, and the financial stresses from the global financial turmoil that began in mid-2007 are heightening these tensions.
TL;DR: In this article, the authors discuss excess comovements for the Euro/US dollar and British pound/US Dollar exchange rates, i.e. comovement of exchange rates which are stronger than implied by fundamentals.
Abstract: The aim of this paper is to discuss excess comovements for the Euro/US dollar and British pound/US dollar exchange rates, i.e. we look for comovements of exchange rates which are stronger than implied by fundamentals. The results of the empirical analysis give evidence that excess comovements indeed exist. A long-run analysis on correlations can verify that the correlations dynamics of exchange rates, relative inflation rates, long-term interest rates, economic sentiments and money supply are linked. We found that money supply and prices play major roles. From the investigation of our exchange rate pair it becomes obvious that non-fundamental factors in exchange rates have an important meaning for modelling foreign exchange rates.
01 Jan 2009
TL;DR: This paper investigated the extent to which countries have been able to borrow internationally in their own currency and found that cross-border participation in local currency bonds is highest in countries where investor-friendly institutions and policies have been established.
Abstract: One factor that arguably could have ameliorated both the emerging market crises of the 1990s and the current global crisis is the development of local currency bond markets. We document and discuss the recent surge in local bond market development, particularly evident in emerging economies where reliance on foreign currency debt—and its concomitant currency mismatches—has been substantially reduced. We also investigate the extent to which countries have been able to borrow internationally in their own currency and find that cross-border participation in local currency bonds is highest in countries where investor-friendly institutions and policies have been established.
TL;DR: According to the chartist-fundamentalist approach, exchange rate fluctuations are at least partially driven by the interactions of heterogeneous boundedly rational speculators who use different trading strategies to determine their orders.
Abstract: According to the chartist-fundamentalist approach, exchange rate fluctuations are at least partially driven by the interactions of heterogeneous boundedly rational speculators who use different trading strategies to determine their orders. This framework is guided by the observation that professional foreign exchange market participants indeed rely on both technical and fundamental analysis rules. Our goal is to survey such models and discuss some key mechanisms which may produce endogenous complex exchange rate dynamics.
TL;DR: In this article, the authors investigate the information asymmetry in the foreign exchange market by testing the hypothesis that top trading banks possess superior information on the macroeconomy because they process greater order flow, which, according to the micro-structure literature, helps them aggregate the dispersed information and feel the general movements of the economy.
Abstract: This study investigates information asymmetry in the foreign exchange market by testing the hypothesis that top trading banks possess superior information on the macroeconomy because they process greater order flow, which, according to the micro-structure literature, helps them aggregate the dispersed information and feel the general movements of the economy. Examining the information share of the banks in the Reuters EFX system using indicative GBP–$US data over 5 years, we find that the top 10 banks, out of 100 quoting banks in the market, have a monthly average share of over 70% of total market information, and around 80% during some US macroannouncements. These results suggest the possibility of private information over public news in the foreign exchange market. Copyright © 2009 John Wiley & Sons, Ltd.
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TL;DR: This paper found that the performance of individual forecasters' performance is skill-based, and that superior forecasters are more experienced than the median forecaster and have fewer personnel responsibilities, which suggests that foreign exchange markets may function in less puzzling and irrational ways than is often thought.
Abstract: This paper sheds new light on a long-standing puzzle in the international finance literature, namely, that exchange rate expectations appear inaccurate and even irrational. We find for a comprehensive dataset that individual forecasters' performance is skill-based. 'Superior' forecasters show consistent ability as their forecasting success holds across currencies. They seem to possess knowledge on the role of fundamentals in explaining exchange rate behavior, as indicated by better interest rate forecasts. Superior forecasters are more experienced than the median forecaster and have fewer personnel responsibilities. Accordingly, foreign exchange markets may function in less puzzling and irrational ways than is often thought.
TL;DR: In this paper, the validity of the law of one price (LOP) in international financial markets was investigated by examining the frequency, size and duration of inter-market price differentials for borrowing and lending services.
Abstract: This paper investigates the validity of the law of one price (LOP) in international financial markets by examining the frequency, size and duration of inter-market price differentials for borrowing and lending services (‘one-way arbitrage’). Using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency, we find that the LOP holds on average, but numerous economically significant violations of the LOP arise. The duration of these violations is high enough to make it worthwhile searching for one-way arbitrage opportunities in order to minimize borrowing costs and/or maximize earnings on given funds. We also document that such opportunities decline with the pace of the market and increase with market volatility.
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TL;DR: This paper applied binary-outcome classification tests to show that directional trading forecasts are informative, and out-of-sample loss-function analysis to examine trading performance, concluding that the critical conditioning variable, which is the fundamental equilibrium exchange rate (FEER), is lower when the target currency is overvalued.
Abstract: The carry trade is the investment strategy of going long in high-yield target currencies and short in low-yield funding currencies. Recently, this naive trade has seen very high returns for long periods, followed by large crash losses after large depreciations of the target currencies. Based on low Sharpe ratios and negative skew, these trades could appear unattractive, even when diversified across many currencies. But more sophisticated conditional trading strategies exhibit more favorable payoffs. We apply novel (within economics) binary-outcome classification tests to show that our directional trading forecasts are informative, and out-of-sample loss-function analysis to examine trading performance. The critical conditioning variable, we argue, is the fundamental equilibrium exchange rate (FEER). Expected returns are lower, all else equal, when the target currency is overvalued. Like traders, researchers should incorporate this information when evaluating trading strategies. When we do so, some questions are resolved: negative skewness is purged, and market volatility (VIX) is uncorrelated with returns; other puzzles remain: the more sophisticated strategy has a very high Sharpe ratio, suggesting market inefficiency.
TL;DR: In this article, the authors examined the relationship between emerging Eastern European and Russian equity and currency markets and found clear evidence of Eastern European markets integration within the region and with Russia as well.
Abstract: The purpose of this study is in three folds. First we look at the linkage between Eastern European emerging equity markets and Russia, second we investigate the relationship among the currency markets of Poland, Hungry, Russia and Czech Republic. Finally, we examine the interdependence between Emerging Eastern European and Russian equity and currency markets. We estimate a bivariate GARCH-BEKK model proposed by Engle and Kroner (1995) using weekly returns. We find the evidence of direct linkage between the equity markets, both in regards of returns and volatility, as well as in currency markets. While analyzing the relationship between currency and stock markets we found unidirectional volatility spillovers from currency to stock markets. Results show clear evidence of Eastern European markets integration within the region and with Russia as well.
TL;DR: In this paper, the authors argue that it is mainly due to liquidity and inventory patterns that emerge from the combination of two factors: domestic agents tend to be net buyers of foreign currency and to trade mostly in their country's working hours.
Abstract: This paper sheds light on a puzzling pattern in spot foreign exchange markets: domestic currencies appreciate (depreciate) systematically during foreign (domestic) working hours. This phenomenon spans many years and several exchange rates, and overrides calendar effects. We argue that it is mainly due to liquidity and inventory patterns that emerge from the combination of two factors: domestic agents tend to be net buyers of foreign currency and to trade mostly in their country’s working hours. The prevalence of domestic (foreign) traders demanding the counterpart currency during domestic (foreign) working hours implies sell-price (buy-price) pressure on the domestic currency during domestic (foreign) working hours.
TL;DR: In this paper, the authors introduce the papers presented at a conference held in April 2009 on the global financial crisis and provide a reference source for understanding what happened in each asset class, when and why it happened and the consequences.
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TL;DR: In this article, the impact of algorithmic trading on price discovery and volatility in the foreign exchange market has been studied, showing that the presence of more algorithmic traders is associated with lower volatility.
Abstract: We study the impact that algorithmic trading, computers directly interfacing at high frequency with trading platforms, has had on price discovery and volatility in the foreign exchange market. Our dataset represents a majority of global interdealer trading in three major currency pairs in 2006 and 2007. Importantly, it contains precise observations of the size and the direction of the computer-generated and human-generated trades each minute. The empirical analysis provides several important insights. First, we find evidence that algorithmic trades tend to be correlated, suggesting that the algorithmic strategies used in the market are not as diverse as those used by non-algorithmic traders. Second, we find that, despite the apparent correlation of algorithmic trades, there is no evident causal relationship between algorithmic trading and increased exchange rate volatility. If anything, the presence of more algorithmic trading is associated with lower volatility. Third, we show that even though some algorithmic traders appear to restrict their activity in the minute following macroeconomic data releases, algorithmic traders increase their provision of liquidity over the hour following each release. Fourth, we find that non-algorithmic order flow accounts for a larger share of the variance in exchange rate returns than does algorithmic order flow. Fifth, we find evidence that supports the recent literature that proposes to depart from the prevalent assumption that liquidity providers in limit order books are passive.
01 Jan 2009
TL;DR: In this paper, the authors investigated the volatility of Naira/Dollar exchange rates in Nigeria using GARCH (1,1), GJR-GARCH(1, 1), EGARCH( 1,1) and TS-Garch(1.1) models.
Abstract: This paper investigated the volatility of Naira/Dollar exchange rates in Nigeria using GARCH (1,1), GJR-GARCH(1,1), EGARCH(1,1), APARCH(1,1), IGARCH(1,1) and TS-GARCH(1,1) models. Using monthly data over the period January 1970 to December 2007, Volatility persistence and asymmetric properties are investigated for the Nigerian foreign exchange. The impact of the deregulation of Foreign exchange market on volatility was investigated by presenting results separately for the period before deregulation, Fixed exchange rate period (January 1970August 2006) and managed float regime (September 2006 December 2007). The results from all the models show that volatility is persistent. The result is the same for the fixed exchange rate period and managed float rate regime. The results from all the asymmetry models rejected the hypothesis of leverage effect. This is in contrast to the work of Nelson (1991). The APARCH model and GJR-GARCH model for the managed floating rate regime show the existence of statistically significant asymmetry effect. The TSGARCH and APARCH models are found to be the best models.
TL;DR: This paper investigated the effect of exchange rates on US foreign direct investment (FDI) flows to a sample of 16 emerging market countries using annual panel data for the period 1990-2002.
Abstract: This paper investigates the effect of exchange rates on US foreign direct investment (FDI) flows to a sample of 16 emerging market countries using annual panel data for the period 1990–2002. Three separate exchange rate effects are considered: the value of the local currency (a cheaper currency attracts FDI); expected changes in the exchange rate (expected devaluation implies FDI is postponed); and exchange rate volatility (discourages FDI). The results reveal a negative relationship between FDI and more expensive local currency, the expectation of local currency depreciation, and volatile exchange rates. Stable exchange rate management can be important in attracting FDI.