Market efficiency depends upon rational, profit-motivated investors. Two of the largest communities of currency traders have no profit motive. Central banks trade to dampen volatility. Corporations seek to hedge the currency exposure in their book of business. Currency profits are based not on the movement of the currency, but on the movement of the currency relative to the forward rate. The forward rate is, in turn, based upon interest rates. If an overseas market has a lower interest rate than the domestic market, its currency will trade at enough of a premium in the forward market to equalize the interest rates when they are currency-hedged. But if an overseas market is trading at a lower interest rate than the domestic rate, investment capital will typically be siphoned away from the lower-yielding market into the higher-yielding market, driving its currency down even as its forward rate points up. Central banks’ tendency to intervene to dampen currency volatility has the effect of introducing serial correlation. If a currency that would have rallied 10% rallies only 5% because of government intervention, it will rally by 5% later. There is a statistically significant pattern: A currency that has gone up will, more likely than not, continue to rally, and vice versa.
Read the Complete Article in Financial Analysts Journal
Financial Analysts Journal
CFA Institute Member ContentPublisher Information
Association for Investment Management and Research
6 pages doi.org/10.2469/faj.v49.n5.47ISSN/ISBN: 0015-198X
We’re using cookies, but you can turn them off in Privacy Settings. Otherwise, you are agreeing to our use of cookies. Accepting cookies does not mean that we are collecting personal data. Learn more in our Privacy Policy.
Privacy Settings
Functional cookies, which are necessary for basic site functionality like keeping you logged in, are always enabled.
