Predictability and 'Good Deals' in Currency Markets

54 Pages Posted: 22 Dec 2008

See all articles by Richard M. Levich

Richard M. Levich

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Valerio Potì

University College Dublin

Multiple version iconThere are 3 versions of this paper

Date Written: December 10, 2008

Abstract

This paper studies predictability of currency returns over the period 1971-2006. To assess the economic significance of currency predictability, we construct an upper bound on the explanatory power of predictive regressions. The upper bound is motivated by "no good-deal" restrictions that rule out unduly attractive investment opportunities. We find evidence that predictability often exceeds this bound. Excess-predictability is highest in the 1970s and tends to decrease over time, but it is still present in the final part of the sample period. Moreover, periods of high and low predictability tend to alternate. These stylized facts pose a challenge to Fama's (1970) Efficient Market Hypothesis but are consistent with Lo's (2004) Adaptive Market Hypothesis, coupled with slow convergence towards efficient markets. Strategies that attempt to exploit daily excess-predictability are very sensitive to transaction costs but those that exploit monthly predictability remain attractive even after realistic levels of transaction costs are taken into account and are not spanned by either the Fama and French (1993) equity-based factors or the AFX Currency Management Index.

Keywords: Foreign Exchange, Predictability, Filter Rules, Market Efficiency

JEL Classification: F31, G15

Suggested Citation

Levich, Richard M. and Potì, Valerio, Predictability and 'Good Deals' in Currency Markets (December 10, 2008). Available at SSRN: https://ssrn.com/abstract=1318765 or http://dx.doi.org/10.2139/ssrn.1318765

Richard M. Levich (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0422 (Phone)
212-995-4256 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Valerio Potì

University College Dublin ( email )

M. Smurfit School of Business
Carysfort Avenue, Blackrock
Dublin, Co Dublin
Ireland

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