Market Timing and Predictability in FX Markets

51 Pages Posted: 20 Jun 2016 Last revised: 14 Feb 2022

See all articles by Thomas Andreas Maurer

Thomas Andreas Maurer

The University of Hong Kong; Washington University in St. Louis - John M. Olin Business School; London School of Economics & Political Science (LSE)

Thuy Duong To

University of New South Wales, Sydney; Financial Research Network (FIRN)

Ngoc-Khanh Tran

Finance Dept., Pamplin College of Business, Virginia Tech; Olin Business School- Washington University in St. Louis

Date Written: September 9, 2018

Abstract

We study the economic value of market timing in FX markets, i.e., using information about the conditional Sharpe ratio to adjust the notional value of a conditionally mean-variance efficient currency portfolio. Our strategy trades more (less) aggressively when the conditional risk-return trade-off is more (less) favorable. This leads to a significant improvement in the out-of-sample unconditional Sharpe ratio, skewness and maximum drawdown per 1% expected excess return. The strategy's market timing predicts returns, volatility and skewness in FX markets. Popular currency pricing factors do not explain the strategy's high average excess returns. Our findings suggest that it is costly to impose leverage or risk (i.e., conditional volatility) limits or other inferior market timing policies when constructing currency trading strategies.

Keywords: Market Timing, Predictability, Foreign Exchange, Currency, Carry Trade, Mean-Variance, Estimation Error, Principal Component

JEL Classification: F31, F37, G11, G12, G15, G17

Suggested Citation

Maurer, Thomas Andreas and To, Thuy Duong and Tran, Ngoc-Khanh, Market Timing and Predictability in FX Markets (September 9, 2018). HKUST Finance Symposium 2016: Active Investing and Arbitrage Capital, 29th Australasian Finance and Banking Conference 2016, Available at SSRN: https://ssrn.com/abstract=2797483 or http://dx.doi.org/10.2139/ssrn.2797483

Thomas Andreas Maurer (Contact Author)

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
Hong Kong

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Thuy Duong To

University of New South Wales, Sydney ( email )

School of Banking and Finance,
University of New South Wales
Sydney, 2052
Australia
61295855865 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Ngoc-Khanh Tran

Finance Dept., Pamplin College of Business, Virginia Tech ( email )

1016 Pamplin Hall (0221)
Blacksburg, VA 24060-0221
United States

HOME PAGE: http://https://www.nktran.com/

Olin Business School- Washington University in St. Louis ( email )

One Brookings Dr, Campus Box 1133
St. Louis, MO 63130
United States

HOME PAGE: http://https://www.nktran.com/

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