Currency Momentum Strategies
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What they found
Testing cross-sectional momentum across 48 currencies from 1976 to 2010, the authors found that buying the currencies with the highest past 1 to 12 month returns and selling the lowest earned up to 10% per year, with the strongest results at short (one-month) formation and holding periods. Currency momentum was unrelated to carry and to standard risk factors, but its profits were concentrated in currencies with high transaction costs, high country risk, and high volatility, and the returns were quite variable over time. They interpret it as a limits-to-arbitrage phenomenon that is real but hard to capture at scale.
What you can use
- Currency momentum exists and is distinct from carry, so combining the two diversifies a FX portfolio.
- The profits live disproportionately in minor and emerging-market currencies with wide spreads, so realistic costs matter a lot.
- Currency momentum has multi-year dry spells; it is not a steady source of return.
Caveats
Long-short portfolios across many currencies including illiquid ones; after costs, profits in major currencies alone are much smaller. Sample ends 2010.
Tags: forex, momentum, limits-to-arbitrage, emerging-markets
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.