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Extreme Returns: The Case of Currencies

Carol Osler () and Tanseli Savaser

No 4, Working Papers from Brandeis University, Department of Economics and International Business School

Abstract: This paper investigates how active price-contingent trading contributes to extreme returns even in the absence of news. Price-contingent trading, which is common across financial markets, includes algorithmic trading, technical trading, and dynamic option hedging. The paper highlights four properties of such trading that increase the frequency of extreme returns, and then estimates the relative of these properties using data from the foreign exchange market. The four key properties we consider are: (1) high kurtosis in the distribution of order sizes; (2) clustering of trades within the day; (3) clustering of trades at certain prices; and (4) positive and negative feedback between trading and returns. Calibrated simulations indicate that interactions among these properties are at least as important as any single one. Among individual properties, the orders’ size distribution and feedback effects have the strongest influence. Price-contingent trading could account for over half of realized excess kurtosis in currency returns.

Keywords: Crash; Fat Tails; Kurtosis; Exchange Rates; Order Flow; High-Frequency; Microstructure; Jump Process; Value-At-Risk; Risk Management (search for similar items in EconPapers)
JEL-codes: F3 G1 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2010-11
New Economics Papers: this item is included in nep-cmp, nep-ifn, nep-mst and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP04.pdf First version, 2010 (application/pdf)

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Journal Article: Extreme returns: The case of currencies (2011) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:brd:wpaper:04

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