Working Paper: NBER ID: w16491
Authors: Travis J. Berge; Scar Jord; Alan M. Taylor
Abstract: A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and out-of-sample. This holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorable Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of so-called risk factors.
Keywords: Currency Carry Trades; Predictability; Foreign Exchange Market
JEL Codes: C44; F31; F37; G14; G15; G17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| carry, momentum, value, forward curve (G13) | currency returns (F31) |
| conventional risk factors (G22) | currency returns (F31) |
| carry trade profits (G15) | predictive power of signals (C52) |