Showing papers on "Foreign exchange market published in 2011"

Currency Momentum Strategies

Abstract: We provide a broad empirical investigation of momentum strategies in the foreign exchange market. We find a significant cross-sectional spread in excess returns of up to 10% p.a. between past winner and loser currencies. This spread in excess returns is not explained by traditional risk factors, it is partially explained by transaction costs and shows behavior consistent with investor under- and over-reaction. Moreover, cross-sectional currency momentum has very different properties from the widely studied carry trade and is not highly correlated with returns of benchmark technical trading rules. However, there seem to be very effective limits to arbitrage which prevent momentum returns from being easily exploitable in currency markets.

3. Identifying the Relationship between Trade and Exchange Rate Volatility

Abstract: We develop a model of international trade in which international trade depresses real exchange rate volatility and exchange rate volatility impacts trade in products differently according to their degree of differentiation. In particular, commodities are less affected by exchange rate volatility than more highly differentiated products. These insights allow us to simultaneously identify both channels of causation, thereby structurally addressing one of the main shortcomings of the existing empirical literature on the effects of exchange rate volatility on trade — the failure to correct for reverse causality. Using disaggregate trade data for a large number of countries for the period 1970-1997 we find strong results supporting the prediction that trade dampens exchange rate volatility. We find that once we address the reverse-causality problem, the large effects of exchange rate volatility on trade found in some previous literature are greatly reduced. In particular, the estimated effect of currency unions on trade is reduced from 300 percent to be between 10 and 25 percent. ∗Thanks are due to Mark Aguiar, Guillermo Calvo, Robert Feenstra, Erik Hurst, Silvana Tenreyro, Shang-Jin Wei, Kei-Mu Yi, and participants at seminars at Chicago GSB, Federal Reserve System Committee Meeting, LACEA Conference 2003, NBER, Minnesota, RIN Conference 2003, and Wisconsin for helpful suggestions. Any errors are our own.

Currency crises and the evolution of foreign exchange market: Evidence from minimum spanning tree

Abstract: We examined the time series properties of the foreign exchange market for 1990–2008 in relation to the history of the currency crises using the minimum spanning tree (MST) approach and made several meaningful observations about the MST of currencies. First, around currency crises, the mean correlation coefficient between currencies decreased whereas the normalized tree length increased. The mean correlation coefficient dropped dramatically passing through the Asian crisis and remained at the lowered level after that. Second, the Euro and the US dollar showed a strong negative correlation after 1997, implying that the prices of the two currencies moved in opposite directions. Third, we observed that Asian countries and Latin American countries moved away from the cluster center (USA) passing through the Asian crisis and Argentine crisis, respectively.

Limits of Floating Exchange Rates: The Role of Foreign Currency Debt and Import Structure

Abstract: A traditional argument in favor of flexible exchange rates is that they insulate output better from real shocks, because the exchange rate can adjust and stabilize demand for domestic goods through expenditure switching. This argument is weakened in models with high foreign currency debt and low exchange rate pass-through to import prices. The present study evaluates the empirical relevance of these two factors. We analyze the transmission of real external shocks to the domestic economy under fixed and flexible exchange rate regimes for a broad sample of countries in a Panel VAR and let the responses vary with foreign currency indebtedness and import structure. We find that flexible exchange rates do not insulate output better from external shocks if the country imports mainly low pass-through goods and can even amplify the output response if foreign indebtedness is high.

The Use of Flow Analysis in Foreign Exchange: Exploratory Evidence

Abstract: This paper provides questionnaire evidence on the role of flow analysis for professional traders and fund managers. This evidence suggests that besides fundamental information and technical analysis, the analysis of flows provides an independent third type of information for professionals. The proposition that flows can be used to learn about fundamentals is not consistent with the data. Instead, evidence indicates that flows more likely provide insight into semi-fundamental private information, suggesting support for the efficient market hypothesis only in a weak form.

Exchange-Rate Dynamics

Abstract: Variations in the foreign exchange market influence all aspects of the world economy, and understanding these dynamics is one of the great challenges of international economics. This book provides a new, comprehensive, and in-depth examination of the standard theories and latest research in exchange-rate economics. Covering a vast swath of theoretical and empirical work, the book explores established theories of exchange-rate determination using macroeconomic fundamentals, and presents unique microbased approaches that combine the insights of microstructure models with the macroeconomic forces driving currency trading. Macroeconomic models have long assumed that agents--households, firms, financial institutions, and central banks--all have the same information about the structure of the economy and therefore hold the same expectations and uncertainties regarding foreign currency returns. Microbased models, however, look at how heterogeneous information influences the trading decisions of agents and becomes embedded in exchange rates. Replicating key features of actual currency markets, these microbased models generate a rich array of empirical predictions concerning trading patterns and exchange-rate dynamics that are strongly supported by data. The models also show how changing macroeconomic conditions exert an influence on short-term exchange-rate dynamics via their impact on currency trading. Designed for graduate courses in international macroeconomics, international finance, and finance, and as a go-to reference for researchers in international economics, Exchange-Rate Dynamics guides readers through a range of literature on exchange-rate determination, offering fresh insights for further reading and research. Comprehensive and in-depth examination of the latest research in exchange-rate economics Outlines theoretical and empirical research across the spectrum of modeling approaches Presents new results on the importance of currency trading in exchange-rate determination Provides new perspectives on long-standing puzzles in exchange-rate economics End-of-chapter questions cement key ideas Martin D. D. Evans is professor of economics in the Department of Economics and professor of finance in the McDonough School of Business at Georgetown University.

Lessons from the Evolution of Foreign Exchange Trading Strategies

Abstract: The adaptive markets hypothesis posits that trading strategies evolve as traders adapt their behavior to changing circumstances. This paper studies the evolution of trading strategies for a hypothetical trader who chooses portfolios from forex technical rules in major and emerging markets, the carry trade and U.S. equities. The results show that forex trading alone dramatically outperforms the S&P 500. But there is little gain to coordinating forex and equity strategies, which explains why practitioners consider these tools separately. In addition, a backtesting procedure to choose optimal portfolios does not select carry trade strategies until well into the 1990s, which helps to explain the relatively recent surge in interest in this strategy. Forex trading returns dip significantly in the 1990s but recover by the end of the decade and have greatly outperformed an equity position since 1998. Overall, trading rule returns still exist in forex markets – with substantial stability in the types of rules – though they have migrated to emerging markets to a considerable degree.

Technical Analysis in the Foreign Exchange Market

Abstract: This article introduces the subject of technical analysis in the foreign exchange market, with emphasis on its importance for questions of market efficiency. “Technicians” view their craft, the study of price patterns, as exploiting traders’ psychological regularities. The literature on technical analysis has established that simple technical trading rules on dollar exchange rates provided 15 years of positive, risk-adjusted returns during the 1970s and 80s before those returns were extinguished. More recently, more complex and less studied rules have produced more modest returns for a similar length of time. Conventional explanations that rely on risk adjustment and/or central bank intervention do not plausibly justify the observed excess returns from following simple technical trading rules. Psychological biases, however, could contribute to the profitability of these rules. We view the observed pattern of excess returns to technical trading rules as being consistent with an adaptive markets view of the world.

Foreign Exchange Market Efficiency Under Recent Crises: Asia-Pacific Focus

Abstract: The Asia-Pacific region’s currency markets are generally efficient within-country when tested using the Johansen (1991, 1995) cointegration technique whereas market efficiency fails to hold when tested using Fama’s (1984) conventional regression. Using the Pilbeam and Olmo (2011) model, we reconcile these conflicting findings. The Pilbeam and Olmo (2011) model confirms within-country market efficiency. It further confirms that free-float currency markets are more resilient than managed-float currency markets among 12 Asia-Pacific economies. From the across-country perspective, the foreign exchange markets are mostly efficient and the results show that the 1997–1998 Asian financial crisis was a more disturbing event than the 2008–2009 global financial crisis in the region.

The $4 trillion question: what explains FX growth since the 2007 survey?

Abstract: Daily average foreign exchange market turnover reached $4 trillion in April 2010, 20% higher than in 2007. Growth owed largely to the increased trading activity of "other financial institutions", which contributed 85% of the higher turnover. Within this customer category, the growth is driven by high-frequency traders, banks trading as clients of the biggest dealers, and online trading by retail investors. Electronic trading has been instrumental to this increase, particularly algorithmic trading.

Lessons from the evolution of foreign exchange trading strategies

Abstract: The adaptive markets hypothesis posits that trading strategies evolve as traders adapt their behavior to changing circumstances. This paper studies the evolution of trading strategies for a hypothetical trader who chooses portfolios from foreign exchange (forex) technical rules in major and emerging markets, the carry trade, and US equities. The results show that a backtesting procedure to choose optimal portfolios improves upon the performance of nonadaptive rules. We also find that forex trading alone dramatically outperforms the S&P 500, with much larger Sharpe ratios over the whole sample, but there is little gain to coordinating forex and equity strategies, which explains why practitioners consider these tools separately. Forex trading returns dip significantly in the 1990s but recover by the end of the decade and have been markedly superior to an equity position since 1998. Overall, trading rule returns still exist in forex markets—with substantial stability in the types of rules—though they have migrated to emerging markets to a considerable degree.

Dynamic Expectation Formation in the Foreign Exchange Market

Abstract: This paper investigates the time-varying nature of expectation formation rules for institutional investors in the foreign exchange market. Using a unique dataset of survey expectations for four exchange rates, we first distinguish three different general rules. We find a momentum rule, a fundamental rule, and a rule that takes advantage of interest differentials between countries. Apart from heterogeneity in expectation formation rules, we show that the rules are time-varying conditional on a number of different factors, such as the sign of the most recent return, the forecast horizon, the distance to the PPP rate, and the extent to which the rule produces forecast errors vis-a-vis the market exchange rate. Although we find dynamics in expectation formation for all four exchange rates, the results for the currencies against the Japanese yen deviate from the others.

Carry Trades, Monetary Policy and Speculative Dynamics

Abstract: We ask when currency carry trades are associated with destabilizing dynamics in the foreign exchange market, and investigate the role of monetary policy rules in setting of such dynamics. In a model where the exchange rate has a long-term fundamental anchor, we find that carry trades can be stabilizing or destabilizing at shorter horizons, depending on the propensity of capital inflows to overheat the recipient economy. In the destabilizing case, we solve for a unique equilibrium that exhibits the classic pattern of the carry trade recipient currency appreciating for extended periods, punctuated by sharp falls.

Appreciating the Renminbi

Abstract: International pressure to revalue China’s currency stems in part from the expectation that rapid economic growth should be associated with an underlying real exchange rate appreciation. This hinges on the Balassa–Samuelson hypothesis, which sees growth as stemming from improvements in traded sector productivity and associated rises in wages and non-traded prices. Yet, despite extraordinary growth after the mid-1990s China’s real exchange rate showed no tendency to appreciate until after 2004. We use a dynamic general equilibrium model to simulate the economy and show that, during this period, trade reforms and a rising national saving rate were offsetting forces in the presence of elastic labour supply. We then examine the possible determinants of the striking transition to real appreciation thereafter, noting mounting evidence that an improved rural term of trade has tightened China’s labour market. We show that should the Chinese government bow to international pressure by appreciating the renminbi either via an extraordinary monetary contraction or via export disincentives, the consequences would be harmful for both Chinese and global interests.

Emerging Market Currency Excess Returns

Abstract: We consider the excess return from 20 internationally tradable emerging market (EM) currencies against the US dollar It has two contributions. First, we document stylized facts about EM currencies. EM currencies have provided significant equity-like excess returns against major currencies, but with low volatility. Picking EM currencies with a relatively high forward premium raises the portfolio return substantially. Second, our calculation incorporates institutional features of the foreign exchange market, such as lags in settling spot contracts, FX swaps, and bid/ offer spreads. Transaction costs arising from bid/ offer spreads are less than one-fifth of what is typically presumed in the literature. (JEL C58, F31, G15) examine the foreign exchange excess return (the difference between the forward exchange rate and the spot rate at maturity) from taking long positions in 20 internationally tradable emerging market (EM) currencies for the US dollar (USD) investors. Our paper has two contributions. First, it contributes to the vast literature on the failure of uncovered interest rate parity (UIP)1 by providing corroborating facts and some new ones for EM currencies. We do so by utilizing a propriety dataset (Gilmore and Hayashi 201 1) that we believe is superior to publicly available alternatives. Second, our calculation of the excess return takes into account institutional features of the foreign exchange market. They include lags in settling spot contracts, foreign exchange (FX) swaps2, and bid/offer spreads. There are two classes of tests of UIP. One, sometimes called the unconditional

Active Currency Investing and PerformanceBenchmarks

Abstract: No established benchmarks currently exist for evaluating a currency manager’s performance. Some analysts have suggested that known investing styles, such as momentum, purchasing power parity, and carry, can serve as bench-marks, but this approach has several challenges. First, there is no market portfolio. Second, there are many alternative generic factor constructions. Third, different constructions of the same factor may have low correlations. Fourth, the three factors may not provide diversification, and lastly there is no buy-and-hold in the foreign exchange market. An evaluation by Melvin and Shand indicates that professional currency managers’ returns are often generated independently from the generic style factors. Skill in timing is what investors should pay for and some managers demonstrate superior skill in timing the factors. Managers are also skilled at minimizing drawdowns relative to the generic factors. The authors conclude that the use of generic style factors may be a worst-case scenario instead of returns to which a foreign exchange investor may aspire.

The Causality between Stock Market and Foreign Exchange Market of Pakistan

Abstract: It is evidenced from the “goods market theory” and “portfolio balance approach” that the stock index and the Exchange Rate determine each other. This study tries to analyze the dynamic relationship between stock market index and exchange rate. To test Long run relationship between these two variables, Engle-Granger Co-integration test is used and it is evidenced that there is no long run relationship in both variables. To analyze, is there any causation in any direction in the variables? Granger Causality (GC) Test is used. The sample period of this study run over Jan 1995 to Jan 2010. The sample size includes 181 data points of month end closing values of stock market index and exchange rate. The results indicate no causal relationship. The contradicting results of this study to the literature is attributed the unstable political environment in Pakistan.

The International Monetary System: Living with Asymmetry

Abstract: This paper analyzes current stresses in the two key areas that concerned the architects of the original Bretton Woods system: international liquidity and exchange rate management. Despite radical changes since World War II in the market context for liquidity and exchange rate concerns, they remain central to discussions of international macroeconomic policy coordination. To take two prominent examples of specific (and related) coordination problems, liquidity issues are paramount in strategies of national self-insurance through foreign reserve accumulation, while recent attempts by emerging market economies (EMEs) to limit real currency appreciation have relied heavily on nominal exchange rate management. A central message is that a diverse set of potential asymmetries among sovereign member states provides fertile ground for a variety of coordination failures. The paper goes on to discuss institutions and policies that might mitigate some of these inefficiencies.

Foreign exchange trading in emerging currencies: more financial, more offshore

Abstract: Foreign exchange turnover evolves in a predictable fashion with increasing income. As income per capita rises, currency trading cuts loose from underlying current account transactions. In parallel, an increasing share of trading in the currency takes place outside the home country. At given income levels, moreover, currencies with either high or very low yields attract more trading, consistent with their role as target and funding currencies in carry trades.

An Assessment Of The Stock Market And Exchange Rate Dynamics In Industrialized And Emerging Markets

Abstract: This paper adopts an Exponentional General Autoregressive Conditional Heteroskedasticity (EGARCH) framework to explore the relationship between stock prices and exchange rates for two groups of countries: emerging and developed economies. Results show that some positive significant price spillovers from the foreign exchange market to the stock market exist for Canada, Japan, the U.S and India. Findings also show for the developed countries, there is no persistence of volatility in the stock markets and the exchange rate markets. For the emerging economies, findings point to the opposite: volatility is pronounce and enduring.

Economic determinants of foreign direct investment (FDI) in commodity producing sector: A case study of Pakistan

Abstract: This study examines the major economic determinants of FDI inflows in commodity-producing sector of Pakistan, by using time series data (quarterly) covering the period of 1996Q1-2008Q4. Augmented Dickey Fuller (ADF) test has been used to check the sationarity of the data. In this study, Co-integration and Error Correction Model (ECM) are used for estimation. Results reveal that Gross Domestic Product (GDP), Real growth Rate of GDP in Commodity-Producing Sector (GRP), Gross Fixed Capital Formation (GFCF), Foreign Exchange Reserves (FOREX), Degree of Trade Openness (RTO) and Per Capita income (PC) are key determinants of FDI inflows in commodity-producing sector of Pakistan. This study explores that all these variables are found statistically significant with positive signs. It seems that these variables have significant impact on FDI inflows into Pakistan in commodity-producing sector. Key words: FDI, commodity-producing sector, trade openness, GFCF, real growth rate, per capita income, Pakistan.

Dynamic correlation between stock prices and exchange rates

Abstract: This article examined the interaction between stock price and exchange rate and explored their dynamic correlation influenced by the stock market volatility. We used newly developed Smooth Transition Conditional Correlation–Generalized Autoregressive Conditional Heteroscedasticity (STCC–GARCH) model and applied weekly data from Indonesia, Korea, Malaysia, the Philippines, Taiwan and Thailand for the period 2000 to 2008 to test the dynamic correlation hypothesis. The empirical results indicated that there are significant price spillovers from stock market to foreign exchange market for Indonesia, Korea, Malaysia, Thailand and Taiwan. Furthermore, the correlation between stock and foreign exchange markets becomes higher when stock market volatility increases in Asian emerging markets except in the Philippines. These results are important for international investors and managers to devise hedging and diversification strategies for their portfolios. The evidence suggests that investors can hedge risk between ...

Policymaking from a "macroprudential" perspective in emerging market economies

Abstract: Recurrent capital inflows pose important challenges for authorities in emerging market economies seeking to preserve financial stability. Raising interest rates to dampen imbalances that could arise from capital flows can also attract more capital inflows and accentuate appreciation pressures. For this reason authorities have used a number of instruments to mitigate the effects of capital flows, all with financial stability implications. Many of these instruments (eg reserve requirements) may have been used for other purposes but the global financial crisis has raised interest in examining them from a financial stability, or "macroprudential" perspective. This paper reviews some of these instruments, drawing in part on material provided by central banks to the BIS. The instruments include foreign exchange market intervention and foreign reserve accumulation; measures to strengthen bank balance sheets and capital and measures to maintain the quality of credit or to ifnluence credit growth or allocation, and capital controls. Certain implementation issues are also discussed, including signals to respond to, timing of prudential measures and procyclicality and effectiveness and calibration. An unresolved question is how the instruments described are to be used in conjunction with interest rate policy. Over the medium term, these instruments raise concerns because they may impair the development of the financial system.

Foreign exchange trading in emerging currencies: more financial, more offshore

Abstract: Foreign exchange turnover evolves in a predictable fashion with increasing income. As income per capita rises, currency trading cuts loose from underlying current account transactions. In parallel, an increasing share of trading in the currency takes place outside the home country. At given income levels, moreover, currencies with either high or very low yields attract more trading, consistent with their role as target and funding currencies in carry trades.