Predicting the bear currency carry trade market: does it add economic value?

Save this PDF as:

Size: px
Start display at page:

Transcription

6 Taking logs, and using a logarithmic approximation, we have: where r i t+1 and s i t are the logs of R i t+1 and S i t. r i t+1 = s i t+1 s i t (rf t US rf i t ), (2) Alternatively, the investor could rely on the forward market by committing to buy for F t,t+1 the foreign currency forward for a transaction agreed on time t to take place at time t+1. So, F t,t+1 is the forward price of the foreign currency at time t with delivery at time t+1. Under the absence of arbitrage, it follows that Ft,t+1 i S =, t i (1+rf t US ) so that (1+rft i the covered interest rate parity condition is fulfilled. At time t+1 the investor ) liquidates the position, selling the currency for St+1. i The dollar-denominated payoff from this strategy is: and taking logs, we again obtain (2). S Rt+1 i t+1 = i S 1= t+1(1+rf i i 1, (3) St i US (1+rf t ) F i t,t+1 t ) The UIP implies that the expected foreign exchange gain must be offset by the opportunity cost of holding funds in this currency rather than in another, the interest rate differential, and the expected currency excess return should be zero. However, the empirical evidence against the UIP discussed earlier motivates investors to engage in the so-called currency carry trade strategies consisting of selling the foreign currency forward when it is at a forward premium (F i t,t+1>s i t ) and buying the foreign currency forward when it is at a forward discount (F i t,t+1< S i t ). We consider the naïve currency carry trade portfolio that consists of a long position on the three highest yield currencies and a short position on the three lowest yield currencies from a basket of the G10 currencies, delivering a payoff R t+1,carry. This portfolio is rebalanced monthly and implemented through the use of currency forwards implying, in turn, the possibility of highly leveraged positions. Clearly, the naïve currency carry trade portfolio is a zero-investment portfolio that does not require initial investment as it consists of positions in the forward markets only. The choice of this portfolio is motivated by its availability; the Bloomberg FXFB Crncy function reports the profitability of this portfolio Identifying currency carry trade fluctuations We examine the bear currency carry trade market using parametric and nonparametric methods considered in the literature in relation to the prediction of bear and bull stock markets (Chen, 2009), which allow us to characterize the fluctuations A E S T I M AT I O 27

9 ê unrestricted,t+k. Let f ˆ t+k = êrestricted 2,t+k [êunrestricted 2,t+k (Pˆrestricted unrestricted 1,t+k Pˆ1,t+k ) 2 ] be the adjusted mean squared prediction error with the corresponding sample mean f =R 1 t ft+k ˆ. t=r We test for equal adjusted mean squared prediction errors by regressing fˆ t+k on a constant and using the resulting t-statistic as a zero coefficient. A significantly positive t-statistic implies the higher predictive power of the unrestricted model. The critical values are (10%) and (5%) (Clark and West, 2007) Binary choice models The binary time series defined in 2.2.b takes the value one (D t =1) if the currency carry trade market is characterized as a bear market and zero (D t =0) during bull currency carry trade markets. In this study, we apply static binary models to forecast the bear markets using the financial variables x t. We estimate the following probit model: P{D t+k =1}=F(a+bx t ). (9) The in-sample predictive model performance is evaluated by the values of the pseudo- R 2 (Estrella, 1998). Let L unrestricted denote the value of the maximized likelihood and let L restricted denote the value of the maximized likelihood under the constraint that all the coefficients are zero except for the constant. The measure of fit is: Pseudo R 2 = Pseudo R =1 ( ) 2 L ( 2 unrestricted T )Log(L restricted ). (10) L restricted A low (high) value of the pseudo R 2 suggests low (high) predictive power of the explanatory variable. If the pseudo R 2 =1, the model is perfect. To evaluate the out-of-the sample performance of the probit model, we consider the quadratic probability score (QPS) proposed by Diebold and Rudebusch (1989): QPS=T 1 t 2[P (D t+k =1) D t+k ] 2. (11) This statistic ranges from 0 to 2, with a score of 0 corresponding to perfect model accuracy. n 3. Data and empirical results: predicting bear currency carry trade markets In this section, we discuss the choice of the financial variables used to predict bear currency carry markets and describe the dataset used in our empirical analysis. We also present the in-sample and out-of-sample predictive power of each financial 30 A E S T I M AT I O

13 l Table 1. Linear and Markov switching models of stock returns Linear Markov switching m 0.44* m * m * s s * s * P P LogLik This table reports the estimates of linear and Markov switching models of currency carry trade returns. The linear model is r t =m+e t. The Markov switching model is r t =m st +e t with mean/variance (m,s1) 2 in regime 1 and (m,s2) 2 in regime 2. * indicates significance at the 5% level. n Figure 1. Filtered probabilities in state 1 (bear currency carry trade market) 1.00 Filtered probabilities in state 1 (bear markets) /28/1989 8/31/ /31/1991 4/30/1993 8/31/ /29/1995 4/30/1997 8/31/ /31/1999 4/30/2001 Table 2 shows the predictive power of the financial variables using linear models measured at different horizons (1, 3, 6, 12 and 24 months). According to R 2, the FX volatility, the currency carry factor, the US TED spread and the three-month CRB Industrial return have the best goodness-of-fit at horizons of one and three months. For longer horizons, up to 12 months, the US AFD delivers the highest R 2. None of the variables have significant predictive power using a horizon of 24 months. As expected, we find that all the variables, apart from the currency carry factor and the three-month CRB Industrial return, have a positive relationship with the future filtered probability of bear currency carry markets. 8/30/ /31/2003 4/29/2005 8/31/ /31/2007 4/30/2009 8/31/ /30/2011 4/30/ A E S T I M AT I O

14 l Table 2. In-sample predictability test results for predicting bear currency carry trade markets (Model 1: Markov switching model) US TED spread FX volatility ˆ p-value R 2 ˆ p-value R 2 k = k = k = k = k = US AFD Currency carry factor ˆ p-value R 2 ˆ p-value R 2 k = k = k = k = k = Three-month CRB Industrial return Global currency skewness factor ˆ p-value R 2 ˆ p-value R 2 k = k = k = k = k = VIX ˆ p-value R 2 k = k = k = k = k = This table shows the results of the predictive regression model P Bear,t+k = a+bx t +e t, where P Bear,t+k is the filtered probability obtained from the Markov switching model. Bold entries indicate significance at the 5% level. Table 3 presents the chronology of the turning points of bear currency carry trade markets determined using the Bry-Boschan (1971) dating algorithm and the corresponding bull and bear currency carry trade periods. Bull markets (mean troughto-peak period 31 months) are generally longer than bear markets (mean peak-to-trough period nine months), reflecting that for most of the period studied, A E S T I M AT I O 35

15 the currency carry trade was in a bull state. Interestingly, the Bry-Boschan (1971) dating algorithm estimates greater bull market persistence than the Markov switching estimation. The longest bull market period was between November 1998 and November The longest bear market period was between June 2007 and December 2008, corresponding to the initial phase of the subprime crisis that triggered huge losses from the naïve currency carry trade strategy. The mean currency carry trade percentage change during bear (bull) periods is 16% (37%). l Table 3. Turning points of the currency carry trade market and corresponding bull and bear periods Peaks Troughs Bull duration Bull change% Bear duration Bear Change % (months) (months) 1992: : % 1994: : % % 1998: : % % 2005: : % % 2007: : % % 2013: % The first (second) column gives the peak (through) turning points of the currency carry trade strategy described in section 3.2 determined by the Bry and Boschan (1971) dating method. Bull (bear) duration shows the time in month from the last trough (peak) to the next peak (trough). The percentage change of the currency carry trade strategy is denoted by Change%. In Table 4, we present the probit regression results using the non-parametric Bry-Boschan (1971) dating algorithm. The pseudo R 2 values are relatively low and may uncover problems in the static probit models in relation to predicting bear and bull currency carry trade markets. The FX volatility, the currency carry factor and the US TED spread reach the highest goodness-of-fit at horizons of one and three months. l Table 4. In-sample predictability test results for predicting bear currency carry trade markets (Model 2: Bry-Boschan model) US TED spread FX volatility ˆ p-value Pseudo R 2 ˆ p-value Pseudo R 2 k = k = k = k = k = A E S T I M AT I O

16 US AFD Currency carry factor ˆ p-value Pseudo R 2 ˆ p-value Pseudo R 2 k = k = k = k = k = Three-month CRB Industrial return Global currency skewness factor ˆ p-value Pseudo R 2 ˆ p-value Pseudo R 2 k = k = k = k = k = VIX ˆ p-value Pseudo R 2 k = k = k = k = k = This table shows the results of the predictive regression model Pr (D Bear,t+k =1)=F(a+bx t +e t ), where D Bear,t+k is a dummy variable so that D Bear,t+k =1 if in a bear currency carry market and D Bear,t+k =0 if in a bull currency carry market. The bear currency carry trade market is identified using the Bry-Boschan method. Bold entries indicate significance at the 5% level Out-of-sample results In this section, we report the out-of-sample results obtained by setting the out-ofsample period at 2002M1 2013M10. Forecasts are constructed using an expanded window of observations in which the data from the start of the dataset through to the present forecast time are used to obtain a new forecast. This process is repeated until the end of the sample. Table 5 shows that the out-of-sample test results using the nested models (7) and (8) display similar patterns to the in-sample results. For short horizons (one to six months), the FX volatility, the currency carry factor, the US TED spread and the three-month CRB Industrial return have predictive power for future bear currency carry trade probability, estimated using the Markov switching model, and Clark and West s (2007) MSPE-adjusted statistic rejects the equal forecasting accuracy. For longer horizons, most of the variables lack predictive ability, and Clark and West s (2007) MSPE-adjusted statistic does not reject the equal forecasting accuracy of both the restricted and the unrestricted models. A E S T I M AT I O 37

17 l Table 5. Out-of-sample predictability test results for predicting bear currency carry markets: Clark and West s (2007) MSPE-adjusted statistic (Model 1: Markov switching model) k = 1 k = 3 k = 6 k = 12 k = 24 US TED spread FX volatility US AFD Currency carry factor Global currency skewness factor Three-month CRB Industrial return VIX The critical values are 1.282(10%) and (5%). Bold entries indicate significance at the 10% level. The predictive regression model is P Bear,t+k =a+bx t +e t, where P Bear,t+k is the filtered probability obtained from the Markov switching model. The QPS score used to evaluate the out-of-sample predictive ability of financial variables concerning future bear currency carry trade probability, estimated using the Bry-Boschan (1971) algorithm, shows similar values across horizons and financial variables (see Table 6). l Table 6. Out-of-sample predictability test results for probit regression models: Diebold and Rudebusch s (1989) QPS (Model 2: Bry-Boschan method) k = 1 k = 3 k = 6 k = 12 k = 24 US TED spread FX volatility US AFD Currency carry factor Global currency skewness factor Three-month CRB Industrial return VIX This table shows the results of the predictive regression model Pr (D Bear,t+k =1)=F(a+bx t +e t ), where D Bear,t+k is a dummy variable so that D Bear,t+k =1 if in a bear currency carry market and D Bear,t+k =0 if in a bull currency carry market. The bear market is identified using the Bry-Boschan method. The QPS ranges from 0 to 2 with a score of 0 corresponding to perfect accuracy. n 4. Economic implications of predicting bear currency carry trade markets Section examined the evidence of the out-of-sample predictability of bear currency carry trade markets using parametric and non-parametric models that included financial variables as leading indicators, especially for the one- to six-month horizons. 38 A E S T I M AT I O

19 where b represents a vector of coefficients for optimal selection. In order to make these theoretical results operational, we assume that vector Z t is equal to the onemonth bear currency carry market probability forecast, Z t = ˆP 1,t+1. The investor s optimal allocation problem is to maximize expected utility conditional on the set of information available at time t. This problem is mathematically stated as: Max E[U (r p,t+1 (a(z t ;b))) Z t ], (14) b with U(R p,t+1 ;b) denoting the investor s utility and E( Z t ) the mathematical expectation conditional on Z t. The first order conditions of this maximization problem can be expressed as: E(U (r p,t+1 (a(z t ;b)))r t+1,carry Z t )=0, (15) with U ( ) denoting the investor s marginal utility with respect to vector b. Brandt et al. (2009) show that the linear specification of the weight function implies that (15) is equivalent to the following equation obtained from the unconditional version of the optimization problem (14). In particular, the relevant system of equations is: E(U (r p,t+1 (a(z t ;b)))r t+1,carry z t )=0, (16) where the symbol represents Kronecker s product connoting element by element multiplication. The above representation of the optimal asset allocation problem yields a testable representation that can be implemented using generalized method of moments (GMM) techniques (Hansen, 1982). The optimal currency carry trade size bet specification that depends on the bear currency carry trade market probability forecast is: a Carry,t = a(z t ;b) = b 0 +b 1 ˆP1,t+1. (17) We consider the investor s utility function to be isoelastic or CRRA and it takes the following form: (1+rp U (rp t+1 ) = t+1 ) 1 g, (18) 1 g with g the investor s constant relative risk aversion (CRRA) coefficient. If g =1, the utility function is U (rp t+1 )=log (1+rp t+1 ). The expected CRRA utility not only depends on the first and second moments of the currency carry trade return distribution, but also on higher order moments, such as the skewness and kurtosis (Brandt et al., 2009). 40 A E S T I M AT I O

Online appendix to paper Downside Market Risk of Carry Trades

Online appendix to paper Downside Market Risk of Carry Trades A1. SUB-SAMPLE OF DEVELOPED COUNTRIES I study a sub-sample of developed countries separately for two reasons. First, some of the emerging countries

Investing in Foreign Currency is like Betting on your Intertemporal Marginal Rate of Substitution.

Investing in Foreign Currency is like Betting on your Intertemporal Marginal Rate of Substitution. Hanno Lustig UCLA and NBER Adrien Verdelhan Boston University December 13, 2005 Abstract Investors earn

The Foreign Exchange Market Not As Liquid As You May Think

06.09.2012 Seite 1 / 5 The Foreign Exchange Market Not As Liquid As You May Think September 6 2012 1 23 AM GMT By Loriano Mancini Angelo Ranaldo and Jan Wrampelmeyer The foreign exchange market facilitates

Session IX: Lecturer: Dr. Jose Olmo. Module: Economics of Financial Markets. MSc. Financial Economics

Session IX: Stock Options: Properties, Mechanics and Valuation Lecturer: Dr. Jose Olmo Module: Economics of Financial Markets MSc. Financial Economics Department of Economics, City University, London Stock

B.3. Robustness: alternative betas estimation

Appendix B. Additional empirical results and robustness tests This Appendix contains additional empirical results and robustness tests. B.1. Sharpe ratios of beta-sorted portfolios Fig. B1 plots the Sharpe

The relationship between exchange rates, interest rates. In this lecture we will learn how exchange rates accommodate equilibrium in

The relationship between exchange rates, interest rates In this lecture we will learn how exchange rates accommodate equilibrium in financial markets. For this purpose we examine the relationship between

Introduction, Forwards and Futures

Introduction, Forwards and Futures Liuren Wu Zicklin School of Business, Baruch College Fall, 2007 (Hull chapters: 1,2,3,5) Liuren Wu Introduction, Forwards & Futures Option Pricing, Fall, 2007 1 / 35

Fundamentals of Futures and Options (a summary)

Fundamentals of Futures and Options (a summary) Roger G. Clarke, Harindra de Silva, CFA, and Steven Thorley, CFA Published 2013 by the Research Foundation of CFA Institute Summary prepared by Roger G.

Effective downside risk management

Effective downside risk management Aymeric Forest, Fund Manager, Multi-Asset Investments November 2012 Since 2008, the desire to avoid significant portfolio losses has, more than ever, been at the front

Stock market booms and real economic activity: Is this time different?

International Review of Economics and Finance 9 (2000) 387 415 Stock market booms and real economic activity: Is this time different? Mathias Binswanger* Institute for Economics and the Environment, University

Futures Price d,f \$ 0.65 = (1.05) (1.04)

24 e. Currency Futures In a currency futures contract, you enter into a contract to buy a foreign currency at a price fixed today. To see how spot and futures currency prices are related, note that holding

Hedging Illiquid FX Options: An Empirical Analysis of Alternative Hedging Strategies

Hedging Illiquid FX Options: An Empirical Analysis of Alternative Hedging Strategies Drazen Pesjak Supervised by A.A. Tsvetkov 1, D. Posthuma 2 and S.A. Borovkova 3 MSc. Thesis Finance HONOURS TRACK Quantitative

CHAPTER 22: FUTURES MARKETS

CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support

SAMPLE MID-TERM QUESTIONS

SAMPLE MID-TERM QUESTIONS William L. Silber HOW TO PREPARE FOR THE MID- TERM: 1. Study in a group 2. Review the concept questions in the Before and After book 3. When you review the questions listed below,

Algorithmic Trading Session 1 Introduction. Oliver Steinki, CFA, FRM

Algorithmic Trading Session 1 Introduction Oliver Steinki, CFA, FRM Outline An Introduction to Algorithmic Trading Definition, Research Areas, Relevance and Applications General Trading Overview Goals

Discussion of The Returns to Currency Speculation

Discussion of The Returns to Currency Speculation John H. Cochrane January 5, 2007 UIP Uk interest rate = 5%, US interest rate = 2%. Invest in UK? 1. Naive: Yes, Make 3% more 2. Traditional: No, Pound

Is the Forward Exchange Rate a Useful Indicator of the Future Exchange Rate?

Is the Forward Exchange Rate a Useful Indicator of the Future Exchange Rate? Emily Polito, Trinity College In the past two decades, there have been many empirical studies both in support of and opposing

Study on the Volatility Smile of EUR/USD Currency Options and Trading Strategies

Prof. Joseph Fung, FDS Study on the Volatility Smile of EUR/USD Currency Options and Trading Strategies BY CHEN Duyi 11050098 Finance Concentration LI Ronggang 11050527 Finance Concentration An Honors

Predicting the US Real GDP Growth Using Yield Spread of Corporate Bonds

International Department Working Paper Series 00-E-3 Predicting the US Real GDP Growth Using Yield Spread of Corporate Bonds Yoshihito SAITO yoshihito.saitou@boj.or.jp Yoko TAKEDA youko.takeda@boj.or.jp

ICC 103-7. 17 September 2009 Original: French. Study. International Coffee Council 103 rd Session 23 25 September 2009 London, England

ICC 103-7 17 September 2009 Original: French Study E International Coffee Council 103 rd Session 23 25 September 2009 London, England Coffee price volatility Background In the context of its programme

The information content of lagged equity and bond yields

Economics Letters 68 (2000) 179 184 www.elsevier.com/ locate/ econbase The information content of lagged equity and bond yields Richard D.F. Harris *, Rene Sanchez-Valle School of Business and Economics,

Assumptions: No transaction cost, same rate for borrowing/lending, no default/counterparty risk

Derivatives Why? Allow easier methods to short sell a stock without a broker lending it. Facilitates hedging easily Allows the ability to take long/short position on less available commodities (Rice, Cotton,

Investment Insight Diversified Factor Premia Edward Qian PhD, CFA, Bryan Belton, CFA, and Kun Yang PhD, CFA PanAgora Asset Management August 2013

Investment Insight Diversified Factor Premia Edward Qian PhD, CFA, Bryan Belton, CFA, and Kun Yang PhD, CFA PanAgora Asset Management August 2013 Modern Portfolio Theory suggests that an investor s return

Optimization of technical trading strategies and the profitability in security markets

Economics Letters 59 (1998) 249 254 Optimization of technical trading strategies and the profitability in security markets Ramazan Gençay 1, * University of Windsor, Department of Economics, 401 Sunset,

Chapter 5. Conditional CAPM. 5.1 Conditional CAPM: Theory. 5.1.1 Risk According to the CAPM. The CAPM is not a perfect model of expected returns.

Chapter 5 Conditional CAPM 5.1 Conditional CAPM: Theory 5.1.1 Risk According to the CAPM The CAPM is not a perfect model of expected returns. In the 40+ years of its history, many systematic deviations

FIN-40008 FINANCIAL INSTRUMENTS SPRING 2008. Options

FIN-40008 FINANCIAL INSTRUMENTS SPRING 2008 Options These notes describe the payoffs to European and American put and call options the so-called plain vanilla options. We consider the payoffs to these

Probability Weighting of Rare Events and Currency Returns

Probability Weighting of Rare Events and Currency Returns Fousseni Chabi-Yo and Zhaogang Song March 17, 2013 Currency Returns: Carry Trade Strategy Currency carry trade strategy: borrow in countries with

Theories of Exchange rate determination

Theories of Exchange rate determination INTRODUCTION By definition, the Foreign Exchange Market is a market 1 in which different currencies can be exchanged at a specific rate called the foreign exchange

Financial Time Series Analysis (FTSA) Lecture 1: Introduction

Financial Time Series Analysis (FTSA) Lecture 1: Introduction Brief History of Time Series Analysis Statistical analysis of time series data (Yule, 1927) v/s forecasting (even longer). Forecasting is often

Chapter 16: Financial Risk Management

Chapter 16: Financial Risk Management Introduction Overview of Financial Risk Management in Treasury Interest Rate Risk Foreign Exchange (FX) Risk Commodity Price Risk Managing Financial Risk The Benefits

A constant volatility framework for managing tail risk

A constant volatility framework for managing tail risk Alexandre Hocquard, Sunny Ng and Nicolas Papageorgiou 1 Brockhouse Cooper and HEC Montreal September 2010 1 Alexandre Hocquard is Portfolio Manager,

Changes in the Relationship between Currencies and Commodities

Bank of Japan Review 2012-E-2 Changes in the Relationship between Currencies and Commodities Financial Markets Department Haruko Kato March 2012 This paper examines the relationship between so-called commodity

Carry Trades and Currency Crashes Markus K. Brunnermeier, Stefan Nagel, Lasse Pedersen Princeton, Stanford, NYU AEA Meetings, January 2008 BNP (2008) Carry Trades & Currency Crashes AEA, Jan 2008 1 / 23

René Garcia Professor of finance

Liquidity Risk: What is it? How to Measure it? René Garcia Professor of finance EDHEC Business School, CIRANO Cirano, Montreal, January 7, 2009 The financial and economic environment We are living through

CHAPTER 15 INTERNATIONAL PORTFOLIO INVESTMENT SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS

CHAPTER 15 INTERNATIONAL PORTFOLIO INVESTMENT SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. What factors are responsible for the recent surge in international portfolio

Introduction to Equity Derivatives

Introduction to Equity Derivatives Aaron Brask + 44 (0)20 7773 5487 Internal use only Equity derivatives overview Products Clients Client strategies Barclays Capital 2 Equity derivatives products Equity

6. Foreign Currency Options

6. Foreign Currency Options So far, we have studied contracts whose payoffs are contingent on the spot rate (foreign currency forward and foreign currency futures). he payoffs from these instruments are

Stock Returns and Equity Premium Evidence Using Dividend Price Ratios and Dividend Yields in Malaysia

Stock Returns and Equity Premium Evidence Using Dividend Price Ratios and Dividend Yields in Malaysia By David E. Allen 1 and Imbarine Bujang 1 1 School of Accounting, Finance and Economics, Edith Cowan

5 Carry Trades and Currency Crashes

5 Carry Trades and Currency Crashes Markus K. Brunnermeier, Princeton University, NBER, and CEPR Stefan Nagel, Stanford University and NBER Lasse H. Pedersen, New York University, NBER, and CEPR I. Introduction

Target Strategy: a practical application to ETFs and ETCs

Target Strategy: a practical application to ETFs and ETCs Abstract During the last 20 years, many asset/fund managers proposed different absolute return strategies to gain a positive return in any financial

Japanese Retail Investors and The

Japanese Retail Investors and The Carry Trade 1 Introduction The carry trade has been an important source of flows in foreign exchange markets in recent years. While a carry trade is difficult to define

Black Box Trend Following Lifting the Veil

AlphaQuest CTA Research Series #1 The goal of this research series is to demystify specific black box CTA trend following strategies and to analyze their characteristics both as a stand-alone product as

2 Stock Price. Figure S1.1 Profit from long position in Problem 1.13

Problem 1.11. A cattle farmer expects to have 12, pounds of live cattle to sell in three months. The livecattle futures contract on the Chicago Mercantile Exchange is for the delivery of 4, pounds of cattle.

Vanguard research July 2014

The Understanding buck stops here: the hedge return : Vanguard The impact money of currency market hedging funds in foreign bonds Vanguard research July 214 Charles Thomas, CFA; Paul M. Bosse, CFA Hedging

Sensex Realized Volatility Index

Sensex Realized Volatility Index Introduction: Volatility modelling has traditionally relied on complex econometric procedures in order to accommodate the inherent latent character of volatility. Realized

Global Currency Hedging

Global Currency Hedging John Y. Campbell Harvard University Arrowstreet Capital, L.P. May 16, 2010 Global Currency Hedging Joint work with Karine Serfaty-de Medeiros of OC&C Strategy Consultants and Luis

Technical trading rules in the spot foreign exchange markets of developing countries

Journal of Multinational Financial Management 11 (2001) 5968 www.elsevier.com/locate/econbase Technical trading rules in the spot foreign exchange markets of developing countries Anna D. Martin * Fairfield

Introduction to Futures Contracts

Introduction to Futures Contracts September 2010 PREPARED BY Eric Przybylinski Research Analyst Gregory J. Leonberger, FSA Director of Research Abstract Futures contracts are widely utilized throughout

Rethinking Fixed Income

Rethinking Fixed Income Challenging Conventional Wisdom May 2013 Risk. Reinsurance. Human Resources. Rethinking Fixed Income: Challenging Conventional Wisdom With US Treasury interest rates at, or near,

Reading: Chapter 19 Chap. 19. Commodities and Financial Futures 1. The mechanics of investing in futures 2. Leverage 3. Hedging 4. The selection of commodity futures contracts 5. The pricing of futures

Callable Bonds - Structure

1.1 Callable bonds A callable bond is a fixed rate bond where the issuer has the right but not the obligation to repay the face value of the security at a pre-agreed value prior to the final original maturity

2. Discuss the implications of the interest rate parity for the exchange rate determination.

CHAPTER 6 INTERNATIONAL PARITY RELATIONSHIPS AND FORECASTING FOREIGN EXCHANGE RATES SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Give a full definition of arbitrage.

A Primer on Forecasting Business Performance

A Primer on Forecasting Business Performance There are two common approaches to forecasting: qualitative and quantitative. Qualitative forecasting methods are important when historical data is not available.

A Review of Cross Sectional Regression for Financial Data You should already know this material from previous study

A Review of Cross Sectional Regression for Financial Data You should already know this material from previous study But I will offer a review, with a focus on issues which arise in finance 1 TYPES OF FINANCIAL

EVALUATION OF THE PAIRS TRADING STRATEGY IN THE CANADIAN MARKET By Doris Siy-Yap PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER IN BUSINESS ADMINISTRATION Approval

Commodity Trading Advisors AQF 2005 Nicolas Papageorgiou Market size The current size of the global capital markets is estimated to be about \$55 trillion, according to Anjilvel, Boudreau, Johmann, Peskin

JOURNAL OF INVESTMENT MANAGEMENT, Vol. 1, No. 2, (2003), pp. 30 43 SHORT VOLATILITY STRATEGIES: IDENTIFICATION, MEASUREMENT, AND RISK MANAGEMENT 1

JOURNAL OF INVESTMENT MANAGEMENT, Vol. 1, No. 2, (2003), pp. 30 43 JOIM JOIM 2003 www.joim.com SHORT VOLATILITY STRATEGIES: IDENTIFICATION, MEASUREMENT, AND RISK MANAGEMENT 1 Mark Anson a, and Ho Ho a

Buying Call or Long Call. Unlimited Profit Potential

Options Basis 1 An Investor can use options to achieve a number of different things depending on the strategy the investor employs. Novice option traders will be allowed to buy calls and puts, to anticipate

C(t) (1 + y) 4. t=1. For the 4 year bond considered above, assume that the price today is 900\$. The yield to maturity will then be the y that solves

Economics 7344, Spring 2013 Bent E. Sørensen INTEREST RATE THEORY We will cover fixed income securities. The major categories of long-term fixed income securities are federal government bonds, corporate

Review for Exam 2 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems You are not responsible for any topics that are not covered in the lecture note

CAPM, Arbitrage, and Linear Factor Models

CAPM, Arbitrage, and Linear Factor Models CAPM, Arbitrage, Linear Factor Models 1/ 41 Introduction We now assume all investors actually choose mean-variance e cient portfolios. By equating these investors

CHAPTER 11: ARBITRAGE PRICING THEORY

CHAPTER 11: ARBITRAGE PRICING THEORY 1. The revised estimate of the expected rate of return on the stock would be the old estimate plus the sum of the products of the unexpected change in each factor times

General Forex Glossary

General Forex Glossary A ADR American Depository Receipt Arbitrage The simultaneous buying and selling of a security at two different prices in two different markets, with the aim of creating profits without

Option Valuation. Chapter 21

Option Valuation Chapter 21 Intrinsic and Time Value intrinsic value of in-the-money options = the payoff that could be obtained from the immediate exercise of the option for a call option: stock price

Yao Zheng University of New Orleans. Eric Osmer University of New Orleans

ABSTRACT The pricing of China Region ETFs - an empirical analysis Yao Zheng University of New Orleans Eric Osmer University of New Orleans Using a sample of exchange-traded funds (ETFs) that focus on investing

Is Technical Analysis Profitable for Individual Currency Traders? Boris S. Abbey and John A. Doukas *

Is Technical Analysis Profitable for Individual Currency Traders? Boris S. Abbey and John A. Doukas * Journal of Portfolio Management, 2012, 39, 1,142-150 Abstract This study examines whether technical

11 Option. Payoffs and Option Strategies. Answers to Questions and Problems

11 Option Payoffs and Option Strategies Answers to Questions and Problems 1. Consider a call option with an exercise price of \$80 and a cost of \$5. Graph the profits and losses at expiration for various

Information Content of Right Option Tails: Evidence from S&P 500 Index Options

Information Content of Right Option Tails: Evidence from S&P 500 Index Options Greg Orosi* October 17, 2015 Abstract In this study, we investigate how useful the information content of out-of-the-money

INFLATION, INTEREST RATE, AND EXCHANGE RATE: WHAT IS THE RELATIONSHIP?

107 INFLATION, INTEREST RATE, AND EXCHANGE RATE: WHAT IS THE RELATIONSHIP? Maurice K. Shalishali, Columbus State University Johnny C. Ho, Columbus State University ABSTRACT A test of IFE (International

Investing In Volatility

Investing In Volatility By: Anish Parvataneni, CFA Portfolio Manager LJM Partners Ltd. LJM Partners, Ltd. is issuing a series a white papers on the subject of investing in volatility as an asset class.

CFA Examination PORTFOLIO MANAGEMENT Page 1 of 6

PORTFOLIO MANAGEMENT A. INTRODUCTION RETURN AS A RANDOM VARIABLE E(R) = the return around which the probability distribution is centered: the expected value or mean of the probability distribution of possible

A comparison between different volatility models. Daniel Amsköld

A comparison between different volatility models Daniel Amsköld 211 6 14 I II Abstract The main purpose of this master thesis is to evaluate and compare different volatility models. The evaluation is based

CONTRACTS FOR DIFFERENCE

CONTRACTS FOR DIFFERENCE Contracts for Difference (CFD s) were originally developed in the early 1990s in London by UBS WARBURG. Based on equity swaps, they had the benefit of being traded on margin. They

High Frequency Equity Pairs Trading: Transaction Costs, Speed of Execution and Patterns in Returns

High Frequency Equity Pairs Trading: Transaction Costs, Speed of Execution and Patterns in Returns David Bowen a Centre for Investment Research, UCC Mark C. Hutchinson b Department of Accounting, Finance

Market Efficiency and Behavioral Finance. Chapter 12

Market Efficiency and Behavioral Finance Chapter 12 Market Efficiency if stock prices reflect firm performance, should we be able to predict them? if prices were to be predictable, that would create the

Market Risk for Single Trading Positions

Chapter 6 Market Risk for Single Trading Positions Market risk is the risk that the market value of trading positions will be adversely influenced by changes in prices and/or interest rates. For banks,

Risk Parity Portfolios:

SEPTEMBER 2005 Risk Parity Portfolios: Efficient Portfolios Through True Diversification Edward Qian, Ph.D., CFA Chief Investment Officer and Head of Research, Macro Strategies PanAgora Asset Management

Current Accounts in Open Economies Obstfeld and Rogoff, Chapter 2

Current Accounts in Open Economies Obstfeld and Rogoff, Chapter 2 1 Consumption with many periods 1.1 Finite horizon of T Optimization problem maximize U t = u (c t ) + β (c t+1 ) + β 2 u (c t+2 ) +...

DISCLAIMER. A Member of Financial Group

Tactical ETF Approaches for Today s Investors Jaime Purvis, Executive Vice-President Horizons Exchange Traded Funds April 2012 DISCLAIMER Commissions, management fees and expenses all may be associated

EVALUATING THE PERFORMANCE CHARACTERISTICS OF THE CBOE S&P 500 PUTWRITE INDEX

DECEMBER 2008 Independent advice for the institutional investor EVALUATING THE PERFORMANCE CHARACTERISTICS OF THE CBOE S&P 500 PUTWRITE INDEX EXECUTIVE SUMMARY The CBOE S&P 500 PutWrite Index (ticker symbol

FE670 Algorithmic Trading Strategies. Stevens Institute of Technology

FE670 Algorithmic Trading Strategies Lecture 3. Factor Models and Their Estimation Steve Yang Stevens Institute of Technology 09/19/2013 Outline 1 Factor Based Trading 2 Risks to Trading Strategies 3 Desirable

Contents. List of Figures. List of Tables. List of Examples. Preface to Volume IV

Contents List of Figures List of Tables List of Examples Foreword Preface to Volume IV xiii xvi xxi xxv xxix IV.1 Value at Risk and Other Risk Metrics 1 IV.1.1 Introduction 1 IV.1.2 An Overview of Market

Call and Put. Options. American and European Options. Option Terminology. Payoffs of European Options. Different Types of Options

Call and Put Options A call option gives its holder the right to purchase an asset for a specified price, called the strike price, on or before some specified expiration date. A put option gives its holder

CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS

1 CHAPTER 11 INTRODUCTION TO SECURITY VALUATION TRUE/FALSE QUESTIONS (f) 1 The three step valuation process consists of 1) analysis of alternative economies and markets, 2) analysis of alternative industries

CHAPTER 22: FUTURES MARKETS

CHAPTER 22: FUTURES MARKETS 1. a. The closing price for the spot index was 1329.78. The dollar value of stocks is thus \$250 1329.78 = \$332,445. The closing futures price for the March contract was 1364.00,

CHAPTER 8 SUGGESTED ANSWERS TO CHAPTER 8 QUESTIONS

INSTRUCTOR S MANUAL: MULTINATIONAL FINANCIAL MANAGEMENT, 9 TH ED. CHAPTER 8 SUGGESTED ANSWERS TO CHAPTER 8 QUESTIONS. On April, the spot price of the British pound was \$.86 and the price of the June futures

Wealth Management Solutions

Wealth Management Solutions Invest in the Future Life has significant moments. Making sure you re prepared for them is important. But what can you do when the pace of your life leaves you little time to

Mutual Fund Investing Exam Study Guide

Mutual Fund Investing Exam Study Guide This document contains the questions that will be included in the final exam, in the order that they will be asked. When you have studied the course materials, reviewed

Commodities: an asset class in their own right?

PHILIPPE MONGARS, CHRISTOPHE MARCHAL-DOMBRAT Market Operations Directorate Market Making and Monitoring Division Investor interest in commodities has risen in recent years in line with the spectacular

AFM 472. Midterm Examination. Monday Oct. 24, 2011. A. Huang

AFM 472 Midterm Examination Monday Oct. 24, 2011 A. Huang Name: Answer Key Student Number: Section (circle one): 10:00am 1:00pm 2:30pm Instructions: 1. Answer all questions in the space provided. If space

Downside market risk of carry trades

Downside market risk of carry trades Victoria Dobrynskaya 1 First version: March 2010 This version: March 2013 Abstract Carry trades consistently generate high excess returns with high Sharpe ratios. I

Online Appendix for Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets

Online Appendix for Demand for Crash Insurance, Intermediary Constraints, and Risk Premia in Financial Markets Hui Chen Scott Joslin Sophie Ni August 3, 2015 1 An Extension of the Dynamic Model Our model

Evidence: Typically country by country time series regressions, following Fama s original

FX We regoingtoreviewthecurrentstateoffxwork. Inmyopinionit sagoodbit behind the stock and bond work above, which means low-hanging fruit for you to apply the same ideas. (Note Lustig et. al. as a low

Interest Rates and Inflation: How They Might Affect Managed Futures

Faced with the prospect of potential declines in both bonds and equities, an allocation to managed futures may serve as an appealing diversifier to traditional strategies. HIGHLIGHTS Managed Futures have

Tilted Portfolios, Hedge Funds, and Portable Alpha

MAY 2006 Tilted Portfolios, Hedge Funds, and Portable Alpha EUGENE F. FAMA AND KENNETH R. FRENCH Many of Dimensional Fund Advisors clients tilt their portfolios toward small and value stocks. Relative

Derivative Users Traders of derivatives can be categorized as hedgers, speculators, or arbitrageurs.

OPTIONS THEORY Introduction The Financial Manager must be knowledgeable about derivatives in order to manage the price risk inherent in financial transactions. Price risk refers to the possibility of loss

A Trading Strategy Based on the Lead-Lag Relationship of Spot and Futures Prices of the S&P 500

A Trading Strategy Based on the Lead-Lag Relationship of Spot and Futures Prices of the S&P 500 FE8827 Quantitative Trading Strategies 2010/11 Mini-Term 5 Nanyang Technological University Submitted By: