Market Timing and Predictability in FX Markets

Thomas A Maurer, Thuy-Duong Tô and Ngoc-Khanh Tran

Review of Finance, 2023, vol. 27, issue 1, 223-246

Abstract: We study the economic value of market timing in foreign exchange (FX) markets, that is, using information about the conditional Sharpe ratio to adjust the notional value of a conditionally mean–variance efficient currency portfolio. Our strategy trades more (less) aggressively when the conditional risk-return trade-off is more (less) favorable. This leads to a significant improvement in the out-of-sample unconditional Sharpe ratio, skewness, and maximum drawdown per 1% expected excess return. The strategy’s market timing predicts returns, volatility, and skewness in FX markets. Popular currency pricing factors do not explain the strategy’s high average excess returns. Our findings suggest that it is costly to impose leverage or risk (i.e., conditional volatility) limits or other inferior market timing policies when constructing currency trading strategies.

Keywords: Market timing; Leverage limits; Risk limits; FX markets; Mean–variance optimization; Exchange rates; Estimation errors (search for similar items in EconPapers)
JEL-codes: F31 F37 G11 G12 G15 G17 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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