DP8747 Currency Momentum Strategies

Author(s): Lukas Menkhoff, Lucio Sarno, Maik Schmeling, Andreas Schrimpf
Publication Date: January 2012
Keyword(s): Carry Trades, Idiosyncratic Volatility, Limits to Arbitrage, Momentum Returns
JEL(s): F31, G12, G15
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8747

We provide a broad empirical investigation of momentum strategies in the foreign exchange market. We find a significant cross-sectional spread in excess returns of up to 10% p.a. between past winner and loser currencies. This spread in excess returns is not explained by traditional risk factors, it is partially explained by transaction costs and shows behavior consistent with investor under- and over-reaction. Moreover, cross-sectional currency momentum has very different properties from the widely studied carry trade and is not highly correlated with returns of benchmark technical trading rules. However, there seem to be very effective limits to arbitrage which prevent momentum returns from being easily exploitable in currency markets.