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Extreme Returns: The Case of Currencies

  • Carol Osler

    ()

    (International Business School, Brandeis University)

  • Tanseli Savaser

    (Department of Economics, Williams College)

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
Download Restriction: no

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
Contact details of provider: Postal: MS032, P.O. Box 9110, Waltham, MA 02454-9110
Web page: http://www.brandeis.edu/departments/economics/

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  1. Westerfield, Janice Moulton, 1977. "An examination of foreign exchange risk under fixed and floating rate regimes," Journal of International Economics, Elsevier, vol. 7(2), pages 181-200, May.
  2. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2006. "Real-time price discovery in global stock, bond and foreign exchange markets," International Finance Discussion Papers 871, Board of Governors of the Federal Reserve System (U.S.).
  3. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008. "Carry Trades and Currency Crashes," NBER Working Papers 14473, National Bureau of Economic Research, Inc.
  4. Momtchil Pojarliev & Richard M. Levich, 2010. "Detecting Crowded Trades in Currency Funds," NBER Working Papers 15698, National Bureau of Economic Research, Inc.
  5. Savaser, Tanseli, 2011. "Exchange rate response to macronews: Through the lens of microstructure," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(1), pages 107-126, February.
  6. Danielsson, J. & Payne, R., 2002. "Real trading patterns and prices in spot foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 21(2), pages 203-222, April.
  7. Torben G. Andersen, 2001. "Variance-ratio Statistics and High-frequency Data: Testing for Changes in Intraday Volatility Patterns," Journal of Finance, American Finance Association, vol. 56(1), pages 305-327, 02.
  8. Biais, Bruno & Hillion, Pierre & Spatt, Chester, 1995. " An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse," Journal of Finance, American Finance Association, vol. 50(5), pages 1655-89, December.
  9. 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.
  10. Craig Burnside & Martin Eichenbaum & Isaac Kleshchelski & Sergio Rebelo, 2011. "Do Peso Problems Explain the Returns to the Carry Trade?," Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 853-891.
  11. LAHAYE, Jérôme & LAURENT, Sébastien & NEELY, Christopher J., . "Jumps, cojumps and macro announcements," CORE Discussion Papers RP -2413, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  12. Markus K Brunnermeier, 2002. "Bubbles and Crashes," FMG Discussion Papers dp401, Financial Markets Group.
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  15. Stephen Morris & Hyun Song Shin, 2003. "Liquidity Black Holes," Cowles Foundation Discussion Papers 1434, Cowles Foundation for Research in Economics, Yale University.
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  17. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
  18. Berger, David W. & Chaboud, Alain P. & Chernenko, Sergey V. & Howorka, Edward & Wright, Jonathan H., 2008. "Order flow and exchange rate dynamics in electronic brokerage system data," Journal of International Economics, Elsevier, vol. 75(1), pages 93-109, May.
  19. repec:dgr:uvatin:19980017 is not listed on IDEAS
  20. Alain Chaboud & Benjamin Chiquoine & Erik Hjalmarsson & Clara Vega, 2009. "Rise of the machines: algorithmic trading in the foreign exchange market," International Finance Discussion Papers 980, Board of Governors of the Federal Reserve System (U.S.).
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  24. C. L. Osler, 2002. "Stop-loss orders and price cascades in currency markets," Staff Reports 150, Federal Reserve Bank of New York.
  25. Chen, Yu-Lun & Gau, Yin-Feng, 2010. "News announcements and price discovery in foreign exchange spot and futures markets," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1628-1636, July.
  26. Kenneth A. Kavajecz, 2004. "Technical Analysis and Liquidity Provision," Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 1043-1071.
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