DP15653 Currency Anomalies
This paper is the first to study the cross-section of currency excess return predictors. Using real-time data, the results provide evidence that currency excess return predictability is at least in part due to mispricing. First, the risk-adjusted profitability of systematic currency trading strategies decreases significantly after the publication of the underlying academic research, suggesting that market participants learn about mispricing from research publications. Consistent with mispricing, the decline is greater for strategies with larger in-sample profits and lower arbitrage costs. Second, the effect of comprehensive, state-of-the art risk adjustments on trading profits is limited, and signal ranks and alphas decay quickly. Third, in line with biased expectations as opposed to risk as a source of return predictability, analysts’ forecasts are inconsistent with currency predictors, implying that investors trading on them contribute to mispricing.
