Temporal Patterns in Foreign Exchange Returns and Options

Abstract

Although the foreign exchange market is believed to be one of the most efficient financial markets in the world, there is significant evidence that technical analysis is profitable in this market. In this study we investigate the ability of information from the options market to supplement the commonly used information on past prices to predict temporal patterns in foreign exchange returns. We find that information from the options market improves the performance of technical trading strategies. Strategies using information from at-the-money options were more consistently profitable than the most commonly used strategies based on only historical spot exchange rates (past prices). Our results hold out-of-sample as well as in the late nineties, a period when few sources of information have proven reliable. Consequently options appear to contain valuable information regarding future spot exchange rate movements.

Keywords: technical analysis, foreign exchange, derivatives

JEL Classification: G0, G14