Thursday, December 25, 2008

Currncy returns

Richard Levich and Valerio Poti assess 'Predictability and 'Good Deals' in Currency Markets'

The abstract
This paper studies predictability of currency returns over the period
1971-2006. To assess the economic significance of currency
predictability, we construct an upper bound on the explanatory power
of predictive regressions. The upper bound is motivated by "no
good-deal" restrictions that rule out unduly attractive investment
opportunities. We find evidence that predictability often exceeds
this bound. Excess-predictability is highest in the 1970s and tends
to decrease over time, but it is still present in the final part of
the sample period. Moreover, periods of high and low predictability
tend to alternate. These stylized facts pose a challenge to Fama's
(1970) Efficient Market Hypothesis but are consistent with Lo's
(2004) Adaptive Market Hypothesis, coupled with slow convergence
towards efficient markets. Strategies that attempt to exploit daily
excess-predictability are very sensitive to transaction costs but
those that exploit monthly predictability remain attractive even
after realistic levels of transaction costs are taken into account
and are not spanned by either the Fama and French (1993) equity-based
factors or the AFX Currency Management Index

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