March 2, 2015 - Currency Trading
Which method of relative currency valuation works best for currency trading? In their February 2015 paper entitled “Currency Value Strategies”, Ahmad Raza, Ben Marshall and Nuttawat Visaltanachoti run a horse race of four currency value strategies:
- Real Exchange Rate: nominal spot exchange rate with the U.S. dollar times the ratio of local consumer prices in local currency to U.S. consumer prices in U.S. dollars.
- Real Exchange Rate Change: one minus the ratio of the average real exchange rate between 5.5 and 4.5 years ago to the real exchange rate three months ago.
- Purchasing Power Parity: from the Organization for Economic Co-operation and Development (OECD).
- Big Mac Index: raw version from the Economist.
Their approach is to calculate excess returns in U.S. dollars from a portfolio that is iteratively long (short) the fifth of currencies that are most undervalued (overvalued) per each of these four metrics and hold the positions over periods ranging from one week to 12 months. Using weekly and monthly spot and forward foreign exchange rate data for 39 developed and emerging market currencies versus the U,S, dollar during January 1972 through July 2013, they find that: Keep Reading