Currency Trading

The market view of Bitcoin has increasingly shifted from a potentially useful currency to an investment asset with no yield but potentially high capital gain. What are the implications of its success in the latter role? In their October 2024 paper entitled “The Distributional Consequences of Bitcoin”, Ulrich Bindseil and Jürgen Schaaf model a scenario in which the price of Bitcoin rises for the foreseeable future due to persistent collective belief that its price will continue to rise. Modeling assumptions are:

• All Bitcoin has been mined, such that the supply is constant.
• Bitcoin has no impact on the capacity of the economy to produce goods and services because it has no economic value.
• Success stories of early adopters sustain a steady increase in demand from latecomers, satisfied by early adopter selling. With a fixed supply, price depends exclusively on (rising) demand.
• Latecomers finance Bitcoin purchases by reducing consumption and liquidating real assets (which are bought by early adopters).
• Bitcoin wealth stimulates higher consumption by holders, balanced by the lower consumption of others because Bitcoin does not increase economic activity (ignoring for simplicity the possibility of reduction in other investments). In other words, Bitcoin is a zero sum game.
• Everyone eventually buys some Bitcoin (people never holding Bitcoin would fare worse than latecomers).

Based on market experience with Bitcoin and their model, they conclude that: Keep Reading

Are large and sophisticated investors (whales) better than small retail investors (minnows) at timing established crypto-asset markets? In their August 2024 paper entitled “Beneath the Crypto Currents: The Hidden Effect of Crypto ‘Whales'”, Alan Chernoff and Julapa Jagtiani compare short-term timing abilities of whales and minnows trading Ethereum (ETH). Specifically, they explore relationships between next-day ETH returns and ETH holdings in e-wallets of four size groups: (1) more than $1 million (whales); (2) $100,000 to $1 million; (3) $10,000 to $100,000; and, (4) less than $10,000 (minnows). They control for supply of ETH in circulation and major crypto-asset market events. Using daily data for ETH from Coin Metrics, including price (midnight to midnight) and holdings/value by e-wallet size group, during January 2018 through December 2023, they find that:

Keep Reading

How do crypto-asset prices interact with conventional market risks, monetary policy and crypto-specific factors? In their July 2024 paper entitled “What Drives Crypto Asset Prices?”, Austin Adams, Markus Ibert and Gordon Liao investigate factors influencing crypto-asset returns using a sign-restricted, structural vector auto-regressive model. Specifically, they decompose daily Bitcoin returns into components reflecting:

• Monetary policy – estimated from effects of changes in the short-term risk-free rate on crypto-asset prices.
• Conventional risk premiums – estimated from daily interactions of 2-year zero coupon U.S. Treasury notes (T-notes) and the S&P 500 Index to account for changes in risk compensation required for holding traditional financial assets.
• Crypto risk premium – estimated from variations in the risk compensation demanded
  by investors for holding crypto assets as indicated by crypto-asset market liquidity and volatility.
• Level of crypto adoption – estimated from co-movements of Bitcoin and stablecoin market capitalizations to reflect crypto-asset innovation, regulatory changes and sentiment shifts.

Using daily data for the risk-free rate, S&P 500 Index, T-notes, Bitcoin and two stablecoins (USDT and USDC), during January 2019 through February 2024, they find that: Keep Reading

Can investors manage cryptocurrency volatility risk with simple trend following rules? In their August 2024 paper entitled “Trend-following Strategies for Crypto Investors”, Trinh Hue Le and Ummul Ruthbah test simple trend following rules on Bitcoin (BTC), Ether (ETH) and the S&P Cryptocurrency LargeCap-Ex. MegaCap Index. Specifically, they hold the cryptocurrency (cash) when its price is above (at of below) its prior-day simple moving average (SMA) of 20, 65, 150 or 200 days. To assess net profitability, they consider trading frictions of 0.1%, 0.25% or 0.5% of amount traded. They further measure correlations between the movements of cryptocurrencies and those of the Nasdaq 100 Index. Using daily prices for the S&P BTC, ETH and Cryptocurrency LargeCap-Ex. MegaCap indexes starting January 2016, January 2017 and January 2019, respectively, all through January 2023, and contemporaneous daily levels of the NASDAQ 100 Index, they find that:

Keep Reading

Are there predictable dollar exchange rate trends according to which U.S. political party is in power? In their March 2024 paper entitled “Presidential Cycles and Exchange Rates”, Pasquale Della Corte and Hsuan Fu investigate whether the party holding the U.S. presidency predicts the dollar exchange rate. Their presidential cycle starts in November with a presidential election and ends four years later at the end of October. They express all exchange rates in U.S. dollars per unit of foreign currency. They consider currencies of countries with developed and emerging economies, making adjustments for introduction of the euro in January 1999, starting with nine currencies in 1983 and ending with 20 currencies. They relate findings to differences in country interest rates and inflation rates and to shifts in trade policy (tariffs). Using end-of-month dollar exchange rates for the selected currencies, global economic data and a measure of aggregate global trade restrictions during October 1983 through January 2024, they find that:

Keep Reading

What are the implications of mainstream economics for bitcoin? In his March 2024 paper entitled “Bitcoin: What Does Mainstream Economics Have to Say?”, Joshua Hendrickson tackles the following questions:

1. Why does money exist and what role does it play in society? How does bitcoin fit our understanding of this role?
2. What is bitcoin worth?
3. Is bitcoin (or can bitcoin be) a sound form of money?
4. Should governments adopt bitcoin?

His goal is to decipher how economics (not any particular economist) answer these questions. Applying mainstream economic theory, he concludes that: Keep Reading

A subscriber asked whether currency exchange rates exhibit reliable seasonality that may be used to time equities (with a stronger currency implying lower asset prices). To investigate, we look for reliable calendar month effects for the U.S. dollar (USD)-euro exchange rate and for Invesco DB US Dollar Index Bullish Fund (UUP). We further look at how monthly returns for these variables relate to those for SPDR S&P 500 ETF Trust (SPY) as a proxy for the U.S. stock market. Using monthly data for the USD-euro exchange rate since January 1999 and for UUP since March 2007, and corresponding data for SPY, all through November 2022, we find that: Keep Reading

Do formal asset allocation methods specify a portfolio allocation to bitcoin (BTC)? In his September 2022 paper entitled “Optimal Allocation to Cryptocurrencies in Diversified Portfolios”, Artur Sepp applies four quantitative methods to estimate optimal allocations to bitcoin within systematically rebalanced portfolios. He considers: two risk-only methods based on either equal risk contribution or maximum diversification; and, two risk-return methods based on either maximum Sharpe ratio or maximum constant absolute risk aversion utility. For each method, he develops allocations for four portfolios:

1. 100% alternatives without BTC (consisting of HFRX Global Hedge Fund Index, SG Macro Trading Index, SG CTA Index and GLD).
2. 100% alternatives with BTC.
3. 75%/25% conventional assets/alternatives without BTC, with 75% allocation to the 60/40 stocks/bonds iShares Core Growth ETF (AOR) fund and 25% allocation to non-BTC alternatives.
4. 75%/25% conventional assets/alternatives with BTC.

He rebalances each portfolio quarterly employing the most recent five years of monthly return inputs to calculate allocations. Since the BTC series starts in July 2010, initial allocation estimates are for June 2015. Using monthly return data for all assets during July 2010 through August 2022, he finds that:

Keep Reading

Do exchange-traded funds (ETF) that track major currencies support a relative momentum strategy? To investigate, we consider the following four ETFs:

Invesco DB US Dollar Bullish (UUP)
Invesco CurrencyShares Euro Currency (FXE)
Invesco CurrencyShares Japanese Yen (FXY)
WisdomTree Chinese Yuan Strategy (CYB)

We each month rank these ETFs based on past return over lookback intervals ranging from one to 12 months. We consider portfolios of past winners reformed monthly based on Top 1 and on equal-weighted (EW) Top 2 and Top 3 ETFs. The benchmark portfolio is the equally weighted combination of all four ETFs. We present findings in formats similar to those used for the Simple Asset Class ETF Momentum Strategy and the Simple Asset Class ETF Value Strategy. Using monthly adjusted closing prices for the currency ETFs during March 2007 (when three become available) through August 2022, we find that: Keep Reading

A subscriber asked whether a rapid, large (20% or more) individual country currency devaluation versus the U.S. dollar indicates that the country’s stock market will rise the next quarter (with country exports presumably more competitive post-devaluation). To investigate, we select five currency exchange rates versus the U.S. dollar and relate monthly and quarterly changes in these rates to next-month and next-quarter total returns in U.S. dollars on exchange-traded funds (ETF) for respective country stock markets, as follows:

1. Malaysia: Ringgit to U.S. Dollar and iShares MSCI Malaysia ETF (EWM).
2. South Korea: Won to U.S. Dollar and iShares MSCI South Korea ETF (EWY).
3. Brazil: Real to U.S. Dollar and iShares MSCI Brazil ETF (EWZ).
4. China: Yuan Renminbi to U.S. Dollar and SPDR S&P China ETF (GXC).
5. India: Rupee to U.S. Dollar and iShares India 50 ETF (INDY).

We consider both linear relationships and outlier relationships (> 20% devaluations). Using monthly and quarterly changes/dividend-adjusted returns for the selected currency/equity ETF pairs as available (all limited by ETF histories) through June 2022, we find that: Keep Reading