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Extreme Returns: The Case of Currencies

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Author Info

  • Carol Osler

    ()
    (International Business School, Brandeis University)

  • Tanseli Savaser

    (Department of Economics, Williams College)

Abstract

This paper investigates how active price-contingent trading contributes to extreme returns even in the absence of news. Price-contingent trading, which is common across financial markets, includes algorithmic trading, technical trading, and dynamic option hedging. The paper highlights four properties of such trading that increase the frequency of extreme returns, and then estimates the relative of these properties using data from the foreign exchange market. The four key properties we consider are: (1) high kurtosis in the distribution of order sizes; (2) clustering of trades within the day; (3) clustering of trades at certain prices; and (4) positive and negative feedback between trading and returns. Calibrated simulations indicate that interactions among these properties are at least as important as any single one. Among individual properties, the orders’ size distribution and feedback effects have the strongest influence. Price-contingent trading could account for over half of realized excess kurtosis in currency returns.

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File URL: http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP04.pdf
File Function: First version, 2010
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Bibliographic Info

Paper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 04.

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Length: 52 pages
Date of creation: Nov 2010
Date of revision:
Handle: RePEc:brd:wpaper:04

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Postal: MS032, P.O. Box 9110, Waltham, MA 02454-9110
Web page: http://www.brandeis.edu/departments/economics/
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Related research

Keywords: Crash; Fat Tails; Kurtosis; Exchange Rates; Order Flow; High-Frequency; Microstructure; Jump Process; Value-At-Risk; Risk Management;

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References

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Stop Orders Drive Half of Abnormal Currency Moves, Suggests Research
    by admin in HistorySquared on 2011-06-29 19:03:19
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Cited by:
  1. Michael King & Carol Osler & Dagfinn Rime, 2012. "The Market Microstructure Approach to Foreign Exchange: Looking Back and Looking Forward," Working Papers 54, Brandeis University, Department of Economics and International Businesss School.

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