Working Paper: NBER ID: w1197
Authors: John F. O. Bilson; David A. Hsieh
Abstract: This paper presents the results of a post-sample simulation of a speculative strategy using a portfolio of foreign currency forward contracts.The main new features of the speculative strategy are (a)the use of Kalman filters to update the forecasting equation, (b) the allowance for transactions,costs and margin requirements and (c) the endogenous determination of the leveraging of the portfolio. While the forecasting model tended to overestimate profit and underestimate risk, the strategy was still profitable over a three year period and it was possible to reject the hypothesis that the sum of profits was zero. Furthermore, the currency portfolio was found to have an extremely low market risk. Combinations of the speculative currency portfolio with traditional portfolios of U.S. equities resulted in considerable improvements in risk-adjusted returns on capital.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| speculative strategy incorporating Kalman filtering, transaction costs, and endogenous leverage (D84) | profitability over a three-year period (L21) |
| combining speculative currency portfolios with traditional U.S. equity portfolios (G15) | enhances risk-adjusted returns (G11) |
| econometric analysis indicates significant overestimation of expected profits (C51) | misleading speculators regarding actual profitability (D84) |
| econometric analysis indicates significant underestimation of risk (G17) | misleading speculators regarding market risk associated with currency speculation (F31) |
| speculative strategy profitability (D84) | actual profits less than predicted (E25) |
| speculative strategy profitability (D84) | risks greater than anticipated (D81) |
| transaction costs and leveraging (G19) | correlation between currency portfolio returns and the S&P 500 index (G15) |