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Currency Trading

Currency trading (forex or FX) offers investors a way to trade on country or regional fiscal/monetary situations and tendencies. Are there reliable ways to exploit this market? Does it represent a distinct asset class?

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Crypto-asset Research Survey

What is the body of academic research on crypto-assets? In their March 2018 paper entitled “Cryptocurrencies as a Financial Asset: A Systematic Analysis”, Shaen Corbet, Brian Lucey, Andrew Urquhart and Larisa Yarovaya review available research on cryptocurrencies as financial assets. They define crypto-assets as peer-to-peer electronic transaction systems which allow payment by one party directly to another without an intermediary. Such assets are therefore are infinitely divisible and have no physical representation or association with higher authority. Theses assets derive value from the security of an algorithm that records all transactions. The authors segment research into five areas: (1) bubble dynamics, (2) regulation, (3) cybercriminality, (4) diversification, and (5) market efficiency. Based on 87 papers published during 2013 through early 2018 (accelerating in frequency), they conclude that: Keep Reading

Bitcoin, Sustainable or Transitional?

Does Bitcoin have a bright future, or is it only a transitional proof of concept? In their March 2018 paper entitled “Bitcoin: A Revolution?”, Guillaume Haeringer and Hanna Halaburda review incentive mechanisms that make Bitcoin work and discuss current and potential uses of Bitcoin and related technologies. They view Bitcoin as the first successful digital medium of exchange without a trusted third party based on combining cryptographic tools and incentive systems that prevent double-spending. They define a Bitcoin user as any entity holding or receiving Bitcoins and a Bitcoin miner as any entity recording and validating transactions. From the perspective of users, the Bitcoin system is similar to an online banking system that supports only deposits and transfers. From the perspective of miners, the Bitcoin system is a source of rewards from adding new blocks to the blockchain (the only source of new Bitcoins) and from transaction validation fees within their blocks. Based on the body of information about Bitcoin, they conclude that: Keep Reading

Cryptocurrency Primer

How do cryptocurrencies work, and how can investors acquire and hold them? In their January 2018 paper entitled “Crypto-Assets Unencrypted”, Seoyoung Kim, Atulya Sarin and Daljeet Virdi survey cryptocurrency history and technology. They summarize cryptocurrency market sizes, trading volumes and volatilities, with comparisons to major fiat currencies and commodities. They further discuss crypto-asset valuation, regulation and the mechanics of investing in them. Based on cryptocurrency data for January 2013 through early December 2017, with focus on the 20 largest cryptocurrencies, they find that: Keep Reading

Timing Bitcoin with SMAs

Are simple moving averages (SMA) useful for timing difficult-to-value Bitcoin? In their January 2018 paper entitled “Bitcoin: Predictability and Profitability Via Technical Analysis”, Andrew Detzel, Hong Liu, Jack Strauss, Guofu Zhou and Yingzi Zhu investigate the use of 5-day, 10-day, 20-day, 50-day or 100-day SMAs to predict Bitcoin returns. Specifically, they test a trading strategy that holds Bitcoins (cash) when current Bitcoin price is above (below) a selected SMA. They assume cash earns the U.S. Treasury bill (T-bill) yield. Using daily Bitcoin prices and T-bill yield, along with data for other variables/assets for comparison, during July 18, 2010 through December 12, 2017, they find that: Keep Reading

The BGSV Portfolio

How might an investor construct a portfolio of very risky assets? To investigate, we consider:

  • Diversifying (based on pairwise correlations) by combining: (1) Bitcoin Investment Trust (GBTC), representing a very long-term option on Bitcoins; (2) VanEck Vectors Junior Gold Miners ETF (GDXJ), representing a very long-term option on gold; and, (3) ProShares Short VIX Short-Term Futures (SVXY), to capture the U.S. stock market volatility risk premium by shorting short-term S&P 500 Index implied volatility (VIX) futures.
  • Capturing upside volatility and managing portfolio drawdown via monthly rebalancing and gain-skimming to a cash position.

We assume equal initial allocations of $10,000 to each of the three risky assets and $0 to cash. If the risky assets have a month-end combined value less than the combined initial allocations, we rebalance them to equal weights for next month. If the risky assets have a combined month-end value greater than the combined initial allocations, we rebalance to the initial allocations and move the excess permanently (skim) to cash. We assume monthly portfolio reformation frictions of 2% of month-end combined values of risky assets. We assume accrued, skimmed cash earns the 3-month U.S. Treasury bill (T-bill) yield. Using monthly adjusted values of GBTC, GDXJ and SVXY and contemporaneous T-bill yield during May 2015 (limited by GBTC) through mid-February 2018, we find that:

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Bitcoin Return Based on Supply and Demand Model

Does the increase in number of Bitcoin wallets at a rate that far exceeds growth in number of Bitcoins explain the dramatic rise in Bitcoin price? In the December revision of his paper entitled “Metcalfe’s Law as a Model for Bitcoin’s Value”, Timothy Peterson models Bitcoin price according to Metcalfe’ Law, which posits that the value of a network (Bitcoin) is a function of the number of possible pair connections (among Bitcoin wallets, assuming all are equal) and is therefore proportional to the square of the number of participants. Said differently, he models Bitcoin value based on supply (number of Bitcoins) and demand (number of Bitcoin wallets). Per Metcalfe’s Law, Bitcoin return is proportional to twice the growth rate of Bitcoin wallets. He tests the model via a least squares regression of actual Bitcoin price on modeled price with adjustment for inflation due to new Bitcoin creation. He applies the model to investigate claims of Bitcoin price manipulation during 2013-2014. Using number of Bitcoins and number of Bitcoin wallets at 60-day intervals during December 31, 2011 through September 30, 2017, he finds that:

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Crypto-manias?

Are there rational ways to decide whether cryptocurrencies such as Bitcoin are in bubbles? In their December 2017 paper entitled “Datestamping the Bitcoin and Ethereum Bubbles”, Shaen Corbet, Brian Lucey and Larisa Yarovaya test for bubbles in Bitcoin and Ethereum price series. For valuation, they consider three potential cyrptocurrency price drivers:

  1. Blockchain length, reflecting difficulty of finding a new block and receiving payment relative to past difficulty. As more miners engage, the rate of block creation increases, raising the level of difficulty.
  2. Hash rate, indicating speed of blockchain code execution during mining. A higher hash rate increases probability of finding the next block and receiving payment. 
  3. Liquidity, measuring the relationship between cryptocurrency daily returns and volatilities. 

They then apply ratios constructed from these variables to detect times when price series are substantially disconnected from fundamental drivers. Using Bitcoin data since July 18, 2010 and Ethereum data since July 30, 2015, both through November 9, 2017, they find that: Keep Reading

Cryptocurrencies vs. Other Asset Classes

Are cryptocurrencies potentially useful portfolio diversifiers? In their November 2017 paper entitled “Exploring the Dynamic Relationships between Cryptocurrencies and Other Financial Assets”, Shaen Corbet, Andrew Meegan, Charles Larkin, Brian Lucey and Larisa Yarovaya apply a battery of tests to analyze relationships: (1) among three cryptocurrencies; and, (2) between the cryptocurrencies and conventional asset classes. They consider cryptocurrencies with market values over $1B at the end July 2017: Bitcoin, Ripple and Litecoin. They consider equities (S&P 500 Index), bonds (Markit ITTR110), commodities (S&P GSCI Total Returns Index), currencies (U.S. Dollar Broad Index), gold (COMEX close) and S&P 500 implied volatility (VIX) as conventional asset classes. Using daily data for Bitcoin, Ripple and Litecoin and for conventional asset classes as specified during April 29, 2013 through April 30, 2017, they find that: Keep Reading

Exploitability of Deep Value across Asset Classes

Is value investing particularly profitable when the price spread between cheap and expensive assets (the value spread) is extremely large (deep value)? In their November 2017 paper entitled “Deep Value”, Clifford Asness, John Liew, Lasse Pedersen and Ashwin Thapar examine how the performance of value investing changes when the value spread is in its largest fifth (quintile). They consider value spreads for seven asset classes: individual stocks within each of four global regions (U.S., UK, continental Europe and Japan); equity index futures globally; currencies globally; and, bond futures globally. Their measures for value are:

  • Individual stocks – book value-to-market capitalization ratio (B/P).
  • Equity index futures – index-level B/P, aggregated using index weights.
  • Currencies – real exchange rate based on purchasing power parity.
  • Bonds – real bond yield (nominal bond yield minus forecasted inflation).

For each of the seven broad asset classes, they each month rank assets by value. They then for each class form a hedge portfolio that is long (short) the third of assets that are cheapest (most expensive). For stocks and equity indexes, they weight portfolio assets by market capitalization. For currencies and bond futures, they weight equally. To create more deep value episodes, they construct 515 sub-classes from the seven broad asset classes. For asset sub-classes, they use hedge portfolios when there are many assets (272 strategies) and pairs trading when there are few (243 strategies). They conduct both in-sample and out-of-sample deep value tests, the latter buying value when the value spread is within its top inception-to-date quintile and selling value when the value spread reverts to its inception-to-date median. Using data as specified and as available (starting as early as January 1926 for U.S. stocks and as late as January 1988 for continental Europe stocks) through September 2015, they find that:

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Asset Class Value Spreads

Do value strategy returns vary exploitably over time and across asset classes? In their October 2017 paper entitled “Value Timing: Risk and Return Across Asset Classes”, Fahiz Baba Yara, Martijn Boons and Andrea Tamoni examine the power of value spreads to predict returns for individual U.S. equities, global stock indexes, global government bonds, commodities and currencies. They measure value spreads as follows:

  • For individual stocks, they each month sort stocks into tenths (deciles) on book-to-market ratio and form a portfolio that is long (short) the value-weighted decile with the highest (lowest) ratios.
  • For global developed market equity indexes, they each month form a portfolio that is long (short) the equally weighted indexes with book-to-price ratio above (below) the median.
  • For each other asset class, they each month form a portfolio that is long (short) the equally weighted assets with 5-year past returns below (above) the median.

To quantify benefits of timing value spreads, they test monthly time series (in only when undervalued) and rotation (weighted by valuation) strategies across asset classes. To measure sources of value spread variation, they decompose value spreads into asset class-specific and common components. Using monthly data for liquid U.S. stocks during January 1972 through December 2014, spot prices for 28 commodities during January 1972 through December 2014, spot and forward exchange rates for 10 currencies during February 1976 through December 2014, modeled and 1-month futures prices for ten 10-year government bonds during January 1991 through May 2009, and levels and book-to-price ratios for 13 developed equity market indexes during January 1994 through December 2014, they find that:

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