The Exchange Rate Effect of Multi-Currency Risk Arbitrage
AbstractThis paper documents how currency speculators trade when international capital flows generate predictable exchange rate movements. The redefinition of the MSCI world equity index in December 2000 provides an ideal natural experiment identifying exogenous capital flows of index tracking equity funds. Currency speculators are shown to front-run international capital flows. Furthermore, they actively manage the portfolio risk of their speculative positions through hedging positions in correlated currencies. The exchange rate effect of separate risk hedging is economically significant and amounts to a return difference of 3.6 percent over a 5 day event window between currencies with high and low risk hedging value. The results of the classical event study analysis are confirmed by a new and more powerful spectral inference isolating the high frequency cospectrum of currency pairs. The evidence supports the idea that international currency arbitrage is limited by the speculators' risk aversion.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7348.
Date of creation: Jun 2009
Date of revision:
Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-07-11 (All new papers)
- NEP-CBA-2009-07-11 (Central Banking)
- NEP-IFN-2009-07-11 (International Finance)
- NEP-OPM-2009-07-11 (Open Economy Macroeconomic)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Payne, Richard & Vitale, Paolo, 2001.
"A Transaction Level Study of the Effects of Central Bank Intervention of Exchange Rates,"
CEPR Discussion Papers
3085, C.E.P.R. Discussion Papers.
- Payne, Richard & Vitale, Paolo, 2003. "A transaction level study of the effects of central bank intervention on exchange rates," Journal of International Economics, Elsevier, vol. 61(2), pages 331-352, December.
- Richard Payne, 2001. "A Transaction Level Study of the Effects of Central Bank Intervention on Exchange Rates," FMG Discussion Papers dp355, Financial Markets Group.
- Hoidal Bjonnes, Geir & Rime, Dagfinn, 2003.
"Dealer Behavior and Trading Systems in Foreign Exchange Markets,"
SIFR Research Report Series
17, Institute for Financial Research.
- Bjonnes, Geir Hoidal & Rime, Dagfinn, 2005. "Dealer behavior and trading systems in foreign exchange markets," Journal of Financial Economics, Elsevier, vol. 75(3), pages 571-605, March.
- Geir Hoidal Bjonnes & Dagfinn Rime, 2003. "Dealer Behavior and Trading Systems in Foreign Exchange Markets," Working Paper 2003/10, Norges Bank.
- Carmen Reinhart & Vincent Reinhart, 2009.
"Capital Flow Bonanzas: An Encompassing View of the Past and Present,"
in: NBER International Seminar on Macroeconomics 2008, pages 9-62
National Bureau of Economic Research, Inc.
- Reinhart, Carmen & Reinhart, Vincent, 2008. "Capital Flow Bonanzas: An Encompassing View of the Past and Present," CEPR Discussion Papers 6996, C.E.P.R. Discussion Papers.
- Carmen M. Reinhart & Vincent R. Reinhart, 2008. "Capital Flow Bonanzas: An Encompassing View of the Past and Present," NBER Working Papers 14321, National Bureau of Economic Research, Inc.
- Edison, H.J., 1993. "The Effectiveness of Central-Bank Intervention: A Survey of the Litterature after 1982," Princeton Studies in International Economics 18, International Economics Section, Departement of Economics Princeton University,.
- Pavlova, Anna & Rigobon, Roberto, 2004.
"Asset Prices and Exchange Rates,"
4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Roberto Rigobon & Anna Pavlova, 2004. "Asset Prices and Exchange Rates," Econometric Society 2004 North American Winter Meetings 579, Econometric Society.
- Pavlova, Anna & Rigobon, Roberto, 2003. "Asset Prices and Exchange Rates," Working papers 4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Anna Pavlova & Roberto Rigobon, 2003. "Asset Prices and Exchange Rates," NBER Working Papers 9834, National Bureau of Economic Research, Inc.
- Hau, Harald & Massa, Massimo & Peress, Joël, 2005.
"Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change,"
CEPR Discussion Papers
4862, C.E.P.R. Discussion Papers.
- Harald Hau & Massimo Massa & Joel Peress, 2010. "Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change," Review of Financial Studies, Society for Financial Studies, vol. 23(4), pages 1681-1717, April.
- Kenneth A. Froot & Tarun Ramadorai, 2005. "Currency Returns, Intrinsic Value, and Institutional-Investor Flows," Journal of Finance, American Finance Association, vol. 60(3), pages 1535-1566, 06.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.