Working Paper: CEPR ID: DP8747
Authors: Lukas Menkhoff; Lucio Sarno; Andreas Schrimpf; Maik Schmeling
Abstract: 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, cross-sectional currency momentum has very different 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.
Keywords: momentum returns; carry trades; idiosyncratic volatility; limits to arbitrage
JEL Codes: F31; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| momentum strategies (C69) | excess returns (D46) |
| transaction costs (D23) | profitability of momentum strategies (G11) |
| investor underreaction and overreaction (G41) | persistence of momentum profits (D25) |
| momentum returns (C69) | transaction costs (D23) |
| momentum strategies (C69) | observed returns (G17) |
| momentum strategies (C69) | limits to arbitrage (G19) |