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Currency Momentum Strategies

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  • Lukas Menkhoff
  • Lucio Sarno
  • Maik Schmeling
  • Andreas Schrimpf

Abstract

We provide a broad empirical investigation of momentum strategies in the foreign exchange market. We find a signiffcant cross-sectional spread in excess returns of up to 10% p.a. between past winner and loser currencies. This spread in excess returns is not explained by traditional risk factors, it is partially explained by transaction costs and shows behavior consistent with investor under- and over-reaction. Moreover, crosssectional currency momentum has very different properties from the widely studied carry trade and is not highly correlated with returns of benchmark technical trading rules. However, there seem to be very effective limits to arbitrage which prevent momentum returns from being easily exploitable in currency markets.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 366.

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Length: 89 pages
Date of creation: Dec 2011
Date of revision:
Handle: RePEc:bis:biswps:366

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Keywords: Momentum Returns; Limits to Arbitrage; Idiosyncratic Volatility; Carry Trades;

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Cited by:
  1. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2013. "The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation," CAMA Working Papers 2013-24, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  2. Cenedese, Gino & Sarno, Lucio & Tsiakas, Ilias, 2014. "Foreign exchange risk and the predictability of carry trade returns," Journal of Banking & Finance, Elsevier, vol. 42(C), pages 302-313.
  3. Christian D. Dick & Lukas Menkhoff, 2013. "Exchange Rate Expectations of Chartists and Fundamentalists," CESifo Working Paper Series 4181, CESifo Group Munich.
  4. Karnaukh, Nina & Ranaldo, Angelo & Söderlind, Paul, 2013. "Understanding FX Liquidity," Working Papers on Finance 1315, University of St. Gallen, School of Finance.
  5. Travis J. Berge, 2011. "Forecasting disconnected exchange rates," Research Working Paper RWP 11-12, Federal Reserve Bank of Kansas City.
  6. Malliaris, A.G. & Malliaris, Mary, 2011. "Are foreign currency markets interdependent? evidence from data mining technologies," MPRA Paper 35261, University Library of Munich, Germany.
  7. Tajaddini, Reza & Crack, Timothy Falcon, 2012. "Do momentum-based trading strategies work in emerging currency markets?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(3), pages 521-537.
  8. ter Ellen, Saskia & Verschoor, Willem F.C. & Zwinkels, Remco C.J., 2013. "Dynamic expectation formation in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 75-97.
  9. Dagfinn Rime & Andreas Schrimpf, 2013. "The anatomy of the global FX market through the lens of the 2013 Triennial Survey," BIS Quarterly Review, Bank for International Settlements, December.
  10. Atanasov, Victoria & Nitschka, Thomas, 2014. "Currency excess returns and global downside market risk," Journal of International Money and Finance, Elsevier, vol. 47(C), pages 268-285.
  11. Nucera, Federico & Valente, Giorgio, 2013. "Carry trades and the performance of currency hedge funds," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 407-425.
  12. Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2012. "Trend Following, Risk Parity and Momentum in Commodity Futures," Discussion Papers 12/28, Department of Economics, University of York.
  13. Christopher J. Neely & Paul A. Weller, 2011. "Lessons from the evolution of foreign exchange trading strategies," Working Papers 2011-021, Federal Reserve Bank of St. Louis.
  14. Jacob Gyntelberg & Andreas Schrimpf, 2011. "FX strategies in periods of distress," BIS Quarterly Review, Bank for International Settlements, December.
  15. Raza, Ahmad & Marshall, Ben R. & Visaltanachoti, Nuttawat, 2014. "Is there momentum or reversal in weekly currency returns?," Journal of International Money and Finance, Elsevier, vol. 45(C), pages 38-60.

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