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Mispricing and Risk Premia in Currency Markets

Published online by Cambridge University Press:  11 December 2023

Söhnke M. Bartram Open the ORCID record for Söhnke M. Bartram [Opens in a new window] ,
Leslie Djuranovik ,
Anthony Garratt  and
Yan Xu
Söhnke M. Bartram*
Affiliation:
Centre for Economic Policy Research (CEPR) University of Warwick, Warwick Business School
Leslie Djuranovik
Affiliation:
Bank Indonesia, Department of Economic and Monetary Policy [email protected]
Anthony Garratt
Affiliation:
University of Warwick, Warwick Business School [email protected]
Yan Xu
Affiliation:
University of Hong Kong, Business School [email protected]
*
[email protected] (corresponding author)
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Abstract

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Using real-time data, we show that currency excess return predictability is in part due to mispricing. First, the risk-adjusted profitability of systematic trading strategies decreases after dissemination of the underlying academic research, suggesting that market participants learn about mispricing from publications. Moreover, the decline is greater for strategies with larger in-sample profits and lower arbitrage costs. Second, the effect of comprehensive risk adjustments on trading profits is limited, and signal ranks and alphas decay quickly. The finding that analysts’ forecasts are inconsistent with currency predictors implies that investors’ trading contributes to mispricing and suggests biased expectations as a possible explanation.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 39
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We greatly appreciate helpful comments and suggestions by an anonymous referee, Hendrik Bessembinder (the editor), as well as Francisco Pinto Avalos, Florian Bardong (Allianz Global Investors), Pedro Barroso, Peter Bossaerts, Gurvinder Brar (Macquarie), Greg Brown, Jason Cen, Ines Chaib, Yen-Cheng Chang, Yixin Chen, Tarun Chordia, Jennifer Conrad, John Cotter, Anirudh Dhawan, Peter Dixon (Commerzbank), Wenxin Du, Gunter Dufey, Bernard Dumas, Ana Galvao, Federico Gavazzoni, Navenn Gonghi, Mark Grinblatt, Jeremy Hale (Citigroup), James Hamilton, Harald Hau, Terrence Hendershott, Alex Hsu, Feng Jiao, Pab Jotikasthira, Andrew Karolyi, Kristjan Kasikov (Citigroup), Peter Kelly, Sehoon Kim, Suk-Joong Kim, Ralph Koijen, Ingomar Krohn, Jongsub Lee, Richard Levich, Harald Lohre (Invesco), Alberto Martin-Utrera, Adrien Matray, Michael Melvin, Bruce Morley, Philippe Mueller, Stefan Nagel, Stavros Panageas, George Panayotov, Lasse Pedersen, Jylhä Petri, Jeffrey Pontiff, Dennis Quinn, Kirsten Rohde, Nikolai Roussanov, Gideon Saar, Riccardo Sabbatucci, Lucio Sarno, Olivier Scaillet, Martin Schindler, Duncan Shand (Schroders Investment Management), Guillaume Simon (Capital Fund Management), Ron Smith, Fabricius Somogyi, Andreas Stathopoulos, René Stulz, Vladyslav Sushko, David Thesmar, Fabio Trojani, Philip Valta, Christian Wagner, Michael Weber, Mungo Wilson, Robin Winkler (Deutsche Bank), Ying Wu, Garry Young (NIESR), Tony Zhang, and seminar participants at American University Beirut, Banque de France, Cambridge University, CERGE-EI, Citigroup, Collegio Carlo Alberto, Frankfurt School of Finance and Management, George Washington University, Goethe University Frankfurt, IMF, Invesco, King’s College London, Lancaster University, Oxford University, Swiss Life Asset Managers, University of Florida, University of Geneva, University of Hull, University of Liverpool, University of Sydney, University of York, University of Warwick, University of Wellington, University Paris-Dauphine, Vienna University of Economics and Business, World Bank, 2022 AFA Conference, 2021 Swiss National Bank 11th Workshop on Exchange Rates, 2022 BIS/World Bank/Bank of Canada/Banca d’Italia Public Investors Conference, 2022 AFFI Conference, 2022 EFMA Conference, 2022 FMA European Conference, 2022 Frontiers of Factor Investing Conference, 2021 AFA Conference, 2021 IAAE Conference, 2021 MMF Society Conference, 2021 FMA Conference, 2021 EBES Conference, 2021 AoBF Conference, 2021 LACEA LAMES Conference, 2021 World Finance & Banking Symposium, 2021 IFC Conference, 2021 NZFM Conference, 2020 EMF Conference, 2020 IRM Conference, 2020 EFA Conference, 2020 SFA Conference, 2020 ABFER Annual Conference, 2020 Deutsche Bank Risk Premia and Quantitative Investment Strategies Conference, 2019 EEA Conference, 2019 RES Conference, 2019 MFA Conference, 2019 UBS Quantitative Investment Conference, 2019 Israel Behavioral Finance Conference, 2019 Citi Global Quantitative Research Conference, 2019 Queen Mary University BFWG Conference, 2019 CAMF Asset Pricing Workshop, 2019 Financial Risks International Forum, 2018 SFS Asia-Pacific Cavalcade, 2018 IAF Conference, 2018 Australasian Finance & Banking Conference, 2018 INFINITI Conference Asia-Pacific, 2018 Deutsche Bank Global Quantitative Conference, 2018 GEA Conference, and CFA Societies in Berlin, Frankfurt, Jordan, Kuwait, Lebanon, London, and Singapore. We gratefully acknowledge financial support by the ACATIS Investment Kapitalverwaltungsgesellschaft mbH, BAI, Banque de France, British Academy/Leverhulme Trust, and Collegio Carlo Alberto. Bartram gratefully acknowledges the Humboldt Research Award of the Alexander von Humboldt Foundation. Xu gratefully acknowledges the support from the GRF sponsored by the RGC in Hong Kong No. 17511716.

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