Peter Smith (York) -Carry, Momentum and Trend Following Returns in the Foreign Exchange Market

This week's speaker will be Peter Smith from the University of York with a presentation entitled "Carry, Momentum and Trend Following Returns in the Foreign Exchange Market".

Abstract:

Recent research has confirmed the behaviour of traders that significant excess returns can be achieved from following the predictions of the carry trade of buying currencies with high short-term interest rates. This paper shows that similar sized excess returns can be achieved by following a trend-following strategy which buys long positions in currencies that have achieved positive recent returns and otherwise holds cash. Trend following has received relatively little attention, despite being widely used in futures markets, particularly commodities, for many decades. This paper shows that, whilst a carry trade factor can be regarded as a significantly priced risk factor in the forward foreign exchange market for 39 countries, a trend following factor is also significantly priced. In a two-factor model the carry trade factor is dominated by the trend following factor in terms of economic and statistical significance. The performance of the trend following factor is more surprising given that it does not have the negative skewness or maximum drawdown characteristic which is shown by the carry trade factor. This also makes the trend following strategy of more potential attraction to investment specialists.