Timing Foreign Exchange Markets
Samuel W. Malone
University of the Andes
Robert B. Gramacy
University of Chicago - Booth School of Business
Enrique ter Horst
April 11, 2014
Midwest Finance Association 2013 Annual Meeting Paper
We take a novel approach to short-horizon exchange rate forecasting by using priced, predictable, and traded foreign exchange market factors as fundamentals. Conditional linear and Bayesian treed Gaussian process (BTGP) models with perfect foresight of these carry and dollar factors substantially outperform the random walk with respect to both squared error and profitability-related loss functions for most currencies. These results are driven primarily by information in the dollar factor. For factor timing strategies that exploit factor predictability directly, Sharpe ratios for the carry factor timing strategy are over three times those earned by timing the dollar factor, however. Simple trading strategies based on combining ex ante factor forecasts with rolling BTGP factor models for individual currencies outperform the random walk on directional accuracy, market timing, profitability, and Sharpe ratio measures for the median currency in our worldwide sample.
Number of Pages in PDF File: 44
Keywords: foreign exchange, speculation, Bayesian treed Gaussian process, Anatolyev-Gerko statistic
JEL Classification: F31, G15, G17
Date posted: October 2, 2012 ; Last revised: April 14, 2014
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