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A dynamic index for managed currencies funds using CME currency contracts

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  • P. Lequeux
  • E. Acar

Abstract

The goal of this paper is to equip the investor with the tools and understanding necessary to evaluate managed currencies' investments in a meaningful way. It is shown that managed currency funds might exhibit a common factor because most of the trading managers use similar technical forecasts to trigger their positions in the financial markets. Therefore, a dynamic benchmark is built, based on technical trading rules. Using the stochastic properties of trading rules, three simple moving averages are selected and given equal weight. Then the basket of trading rules is applied to a set of currencies. The weighting between currencies is done according to volumes traded on the OTC market as observed through Reuters 2000. Such a dynamic benchmark when adjusted for the leverage and risk-free factors exhibits similar performances, namely returns and volatility, to currency traders' benchmarks. The degree of correlation is high and the tracking error is low. These results might have several implications for institutions wishing to consider managed currency funds. First, the dynamic index might be used as a test of market inefficiencies. Second, the technical index might be used as a benchmark for currency trading advisers. As a whole, it can be seen that managed currencies have been trend-followers because the correlation coefficient between the dynamic index and the currency managers is significantly positive. The dynamic index might well be used to distinguish trend-followers from contrarian and judgemental fund. Finally, the dynamic index might be used as a tool to fulfil market expectations. On the one hand, an investor anticipating trending markets might wish to buy the dynamic index. On the other hand, an investor forecasting range-trading markets might wish to sell the index. In sum, the dynamic index might constitute a new financial product, as well as an appropriate benchmark for managed currencies funds.

Suggested Citation

  • P. Lequeux & E. Acar, 1998. "A dynamic index for managed currencies funds using CME currency contracts," The European Journal of Finance, Taylor & Francis Journals, vol. 4(4), pages 311-330.
    • Handle: RePEc:taf:eurjfi:v:4:y:1998:i:4:p:311-330
    DOI: 10.1080/135184798337209
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    References listed on IDEAS

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    1. Blake LeBaron, "undated". "Technical Trading Rules and Regime Shifts in Foreign Exchange," Working papers _007, University of Wisconsin - Madison.
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    2. Menkhoff, Lukas & Sarno, Lucio & Schmeling, Maik & Schrimpf, Andreas, 2012. "Currency momentum strategies," Journal of Financial Economics, Elsevier, vol. 106(3), pages 660-684.
    3. Ian Hudson, 2016. "The Currency Carry Trade: Selection Skill or Behavioral Bias," International Business Research, Canadian Center of Science and Education, vol. 9(9), pages 176-185, September.
    4. Moskowitz, Tobias J. & Ooi, Yao Hua & Pedersen, Lasse Heje, 2012. "Time series momentum," Journal of Financial Economics, Elsevier, vol. 104(2), pages 228-250.
    5. Taylor, Mark & Hsu, Po-Hsuan & Wang, Zigan, 2020. "The Out-of-Sample Performance of Carry Trades," CEPR Discussion Papers 15052, C.E.P.R. Discussion Papers.
    6. Potì, Valerio & Levich, Richard M. & Pattitoni, Pierpaolo & Cucurachi, Paolo, 2014. "Predictability, trading rule profitability and learning in currency markets," International Review of Financial Analysis, Elsevier, vol. 33(C), pages 117-129.
    7. Taylor, Mark & Hsu, Po-Hsuan, 2014. "Forty Years, Thirty Currencies and 21,000 Trading Rules: A Large-scale, Data-Snooping Robust Analysis of Technical Trading in t," CEPR Discussion Papers 10018, C.E.P.R. Discussion Papers.
    8. Sam Nasypbek & Scheherazade S Rehman, 2011. "Explaining the returns of active currency managers," BIS Papers chapters, in: Bank for International Settlements (ed.), Portfolio and risk management for central banks and sovereign wealth funds, volume 58, pages 211-256, Bank for International Settlements.
    9. Melvin, Michael & Prins, John & Shand, Duncan, 2013. "Forecasting Exchange Rates: an Investor Perspective," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 721-750, Elsevier.
    10. Levich, Richard M. & Potì, Valerio, 2015. "Predictability and ‘good deals’ in currency markets," International Journal of Forecasting, Elsevier, vol. 31(2), pages 454-472.
    11. Potì, Valerio & Siddique, Akhtar, 2013. "What drives currency predictability?," Journal of International Money and Finance, Elsevier, vol. 36(C), pages 86-106.
    12. Christian Dunis & Jia Miao, 2007. "Trading foreign exchange portfolios with volatility filters: the carry model revisited," Applied Financial Economics, Taylor & Francis Journals, vol. 17(3), pages 249-255.
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    14. Jessica James & Kristjan Kasikov & Kerry-Ann Edwards, 2012. "The end of diversification," Quantitative Finance, Taylor & Francis Journals, vol. 12(11), pages 1629-1636, November.

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