Market Predictability - page 4

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stock_return_predictability_and_economic_value_of_market_timing.pdf

We examine different models of stock market predictability; namely, the Campbell-Shiller (1998) and the Federal Reserve-type models. We find both models to have similar predictive power. We also study possible economic benefits of these models and the Saletta (2006) Emotion Factor model in timing the market. Our findings show that under a contrarian investment approach, the Federal Reserve-type model fares better, but under a momentum investment strategy, the emotion factor outperforms all others. Our findings suggest that market timing strategies provide better economic benefits than a buy-and-hold strategy; thus, offer considerable implications for investors to attempt to time the market.
 

global_variance_risk_premium_and_forex_return_predictability.pdf

In a long-run risk model with stochastic volatility and complete markets, I express expected forex returns as a function of consumption growth variances and equity variance risk premiums (VRPs)| the difference between the risk-neutral and statistical expectations of market return variation. This provides a motivation for using the forward-looking information available in stock market volatility indices to predict forex returns. Empirically, I nd that equity VRPs predict forex returns at a one-month horizon, both in-sample and out-of-sample. Moreover, compared to two major currency carry predictors, global VRP has more predictive power for currency carry trade returns, bilateral forex returns, and excess equity return differentials.
 

foreign_exchange_risk_and_the_predictability_of_carry_trade_returns.pdf

This paper provides an empirical investigation of the time-series predictive ability of foreign exchange risk measures on the return to the carry trade, a popular investment strategy that borrows in low-interest currencies and lends in high-interest currencies. Using quantile regressions, we nd that higher market variance is signi cantly related to large future carry trade losses, which is consistent with the unwinding of the carry trade in times of high volatility. The decomposition of market variance into average variance and average correlation shows that the predictive power of market variance is primarily due to average variance since average correlation is not signi cantly related to carry trade returns. Finally, a new version of the carry trade that conditions on market variance generates performance gains net of transaction costs.
 

predictability_in_financial_markets_-_what_do_survey_expectations_tell_us.pdf

There is widespread evidence of excess return predictability in …financial markets. For the foreign exchange market a number of studies have documented that the predictability of excess returns is closely related to the predictability of expectational errors of excess returns. In this paper we investigate the link between the predictability of excess returns and expectational errors in a much broader set of fi…nancial markets, using data on survey expectations of market participants in the stock market, the foreign exchange market, and the bond and money markets in various countries. Results are striking. First, in markets where there is signi…ficant excess return predictability, expectational errors of excess returns are predictable as well, with the same sign and often even with similar magnitude. This is the case for forex, stock and bond markets. Second, in the only market where excess returns are generally not predictable, the money market, expectational errors are not predictable either. These fi…ndings suggest that an explanation for the predictability of excess returns must be closely linked to an explanation for the predictability of expectational errors.
 

currency_risk_premia_and_macro_fundamentals.pdf

Motivation
  •  Common perception in the profession that exchange rate fluctuations are more or less random and that macro fundamentals have a hard time explaining and/or predicting exchange rates
  •  Influential paper by Meese and Rogo (1983) on the disconnect between macro fundamentals and exchange rates
  •  Some empirical success at longer horizons, but overall little evidence that exchange rates and fundamentals are linked at horizons below one year

This paper:

New evidence on the link between macro fundamentals and currency markets ...
 

currency_momentum_strategies.pdf

We provide a broad empirical investigation of momentum strategies in the foreign exchange market. We find a significant 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 diferent 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.
 

volatility_risk_premia_and_exchange_rate_predictability.pdf

We investigate the predictive information content in foreign exchange volatility risk premia for exchange rate returns. The volatility risk premium is the difference between realized volatility and a model-free measure of expected volatility that is derived from currency options, and re‡flects the cost of insurance against volatility ‡fluctuations in the underlying currency. We …nd that a portfolio that sells currencies with high insurance costs and buys currencies with low insurance costs generates sizeable out-of-sample returns and Sharpe ratios. These returns are almost entirely obtained via predictability of spot exchange rates rather than interest rate differentials, and these predictable spot returns are far stronger than those from carry trade and momentum strategies. Canonical risk factors cannot price the returns from this strategy, which can be understood, however, in terms of a simple mechanism with time-varying limits to arbitrage.
 

technical_trading_rule_proftability_and_foreign_exchange_intervention.pdf

There is reliable evidence that simple rules used by traders have some predictive value over the future movement of foreign exchange prices. This paper will review some of this evidence and discuss the economic magnitude of this predictability. The profitability of these trading rules will then be analyzed in connection with central bank activity using intervention data from the Federal Reserve. The objective is to find out to what extent foreign exchange predictability can be confined to periods of central bank activity in the foreign exchange market. The results indicate that after removing periods in which the Federal Reserve is active, exchange rate predictability is dramatically reduced.
 

what_does_the_yield_curve_tell_us_about_exchange_rate_predictability.pdf

This paper uses information contained in the cross-country yield curves to test the assetpricing approach to exchange rate determination, which models the nominal exchange rate as the discounted present value of its expected future fundamentals. Since the term structure of interest rates embodies information about future economic activity such as GDP growth and inflation, we extract the Nelson-Siegel (1987) factors of relative level, slope, and curvature from cross-country yield differences to proxy expected movements in future exchange rate fundamentals. Using monthly data between 1985-2005 for the United Kingdom, Canada, Japan and the US, we show that the yield curve factors predict bilateral exchange rate movements and explain excess currency returns one month to two years ahead. They also outperform the random walk in forecasting short-term exchange rate returns out of sample. Our findings provide an intuitive explanation to the uncovered interest parity puzzle by relating excess currency returns to inflation and business cycle risk.
 

the_market_impact_of_large_trading_orders_-_correlated_order_fl_ow_asymmetric_liquidity_and_efficien.pdf

We study the price change associated with the incremental execution of large trading orders. The heavy tails of large order sizes leads to persistence in the signs of transactions: Buyer initiated transactions tend to be followed by buyer initiated transactions and seller initiated transactions tend to be followed by seller initiated transactions. The resulting predictability in order ow implies that to preserve market efficiency, liquidity must be asymmetric in the sense that trades of the same same sign as the large order generate smaller returns than returns of the opposite sign. The predictability of order ow increases during the execution of a large order, making returns smaller and causing the overall impact to be a concave function of order size. This depends on the information market participants have about order flow. Under assumptions described in the paper, the theory that we develop predicts the functional form of market impact, the degree to which impact is temporary or permanent, and its dependence on trading velocity. We perform empirical tests using data from the London Stock Exchange.
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