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Dynamic Trading of FX Carry and Momentum Portfolios Lorenzo Bertolini Cass Business School, City University, London June 6, 2009

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This is a presentation on the actual progress of market timing indicators for FX Carry and Momentum portfolios. This presentation will be updated continously.

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Page 1: DynamicFxPortfolios

Dynamic Trading of FX Carry and MomentumPortfolios

Lorenzo Bertolini

Cass Business School, City University, London

June 6, 2009

Page 2: DynamicFxPortfolios

1 Introduction

2 Methodology

3 DataG10 FX and Yield DataG10 FX Carry and Momentum IndicesRisk-Factors & Risk Indicator

4 Benchmark Market Timing RulesMoving-Average Crossover RuleRisk-Indicator Filter RuleMoving Average Crossover/Risk-Indicator Combination

5 Conclusion

6 References

Page 3: DynamicFxPortfolios

Outline

1 Introduction

2 Methodology

3 Data

4 Benchmark Market Timing Rules

5 Conclusion

6 References

Page 4: DynamicFxPortfolios

What is Carry and Momentum Trading?

Definition: Carry Trading

A strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds topurchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture thedifference between the rates, which can often be substantial, depending on the amount of leverage the investorchooses to use.source: http://www.investopedia.com/terms/c/currencycarrytrade.asp

Definition: Momentum Trading

An investment strategy that aims to capitalize on the continuance of existing trends in the market. Themomentum investor believes that large increases in the price of a security will be followed by additional gains andvice versa for declining values.source: http://www.investopedia.com/terms/m/momentum investing.asp

Page 5: DynamicFxPortfolios

Carry and Momentum are popular FX Trading Styles

Carry and Momentum trading styles in FX markets areamongst the most popular trading strategies applied in themanagement of FX portfolios (see e.g. Acar [7], BIS-Survey2007 [5]).

There is evidence for positive returns from trading these twoinvestment styles (see e.g. Acar [7], Dunis [8], [4] andHochradl and Wagner et.al [6]).

Carry and Momentum strategies can incur periods of severedrawdowns (see e.g. Dunis [8]).

Page 6: DynamicFxPortfolios

Factors driving FX Carry and Momentum Returns

Our research builds on three main directions in literature, which study the relationship between FX Carry andMomentum strategy returns and risk-factors:

Timing FX Carry/Momentum with RiskMetrics Volatility Estimates

Dunis [4] ,[8] finds that during periods of low FX market volatility FX Carry and Momentum trading strategiesperform better than they do during periods of high FX market volatility.

Relationship of FX Carry portfolios with risk-factors and monetary variables

Burnside et al. [1] examined the relationship between FX Carry trading returns and risk-related and monetarytimeseries. They found no evidence for a linear relationship on a monthly timeframe.

Risk-Factors as Inputs for Market Timing Indicators

Coudert [3] calculates logistic-regression based early warning indicators with risk-factors as inputs. He achievedgood results when predicting equity market crises and poor results when predicting currency crises.

Page 7: DynamicFxPortfolios

Addressed Research Questions

Question 1

Do risk-factors allow to forecast periods of profitable FX Carryand/or Momentum trading?

Question 2

Do more advanced statistical models outperform simple markettiming rules?

Question 3

Do nonlinear neural network based modeling techniques add valueto the market timing process, thereby indicating nonlinearrelationships between FX Carry/Momentum Indices andrisk-factors?

Page 8: DynamicFxPortfolios

Outline

1 Introduction

2 Methodology

3 Data

4 Benchmark Market Timing Rules

5 Conclusion

6 References

Page 9: DynamicFxPortfolios

Simple Market Timing Benchmarks

We will test three simple market timing models and use them asbenchmarks for the more advanced statistical techniques:

Benchmark Market Timing Models

Simple Moving-Average Crossover Rule

Risk-Indicator Filter Rule

Combined Moving-Average Crossover/Risk-Indicator Rule

Page 10: DynamicFxPortfolios

Statistical Classification Techniques

Several studies have reported enhanced predictability of signs ofreturns versus magnitudes of returns (see e.g. Christoffersen andDiebold [2]). Building on these results we will attempt to classifyperiods with positive FX Carry/Momentum returns and periodswith negative FX Carry/Momentum returns.

Adopted Classification Methods

k-Nearest Neighbors

Logistic Regression

Multi Layer Perceptron Neural Networks

Recurrent Neural Networks

Page 11: DynamicFxPortfolios

Outline

1 Introduction

2 Methodology

3 DataG10 FX and Yield DataG10 FX Carry and Momentum IndicesRisk-Factors & Risk Indicator

4 Benchmark Market Timing Rules

5 Conclusion

6 References

Page 12: DynamicFxPortfolios

Data Overview

We collected data at a weekly frequency from Bloomberg and Datastream. The categories of our data series are:

G10 FX and Yield Data

This data is used for the FX portfolio backtesting routines needed to test dynamic portfolio strategies with timingindicators.

G10 FX Carry and Momentum Indices

For the construction of the FX portfolio timing models, we need to construct FX Carry and FX Momentum indicesand transform their total returns timeseries into binary timeseries.

Risk-Factors & Risk Indicator

Financial risk-factors will serve as inputs to the FX portfolio timing models.

Page 13: DynamicFxPortfolios

G10 1-Week Yields

Series DescriptionEU0001W INDEX EUR 1 WEEK YIELDSUS0001W INDEX USD 1 WEEK YIELDSJY0001W INDEX JPY 1 WEEK YIELDSBP0001W INDEX GBP 1 WEEK YIELDSSF0001W INDEX CHF 1 WEEK YIELDSCD0001W INDEX CAD 1 WEEK YIELDSAU0001W INDEX AUD 1 WEEK YIELDSNZ0001W INDEX NZD 1 WEEK YIELDSNIBOR1W INDEX NOK 1 WEEK YIELDSSK0001W INDEX SEK 1 WEEK YIELDS

Table: G10 1-Week Yield DataOverview (source: Bloomberg)

G10 1-Week Yield Data

EU

0001

W_I

ND

EX

12

34

5

US

0001

W_I

ND

EX

02

46

8

JY00

01W

_IN

DE

X

01

23

45

6

BP

0001

W_I

ND

EX

24

68

01

23

4

SF

0001

W_I

ND

EX

1980 1985 1990 1995 2000 2005 2010

CD

0001

W_I

ND

EX

12

34

56

AU

0001

W_I

ND

EX

34

56

78

NZ

0001

W_I

ND

EX

46

810

NIB

OR

1W_I

ND

EX

050

100

150

12

34

56

SK

0001

W_I

ND

EX

1980 1985 1990 1995 2000 2005 2010

1W Yield Data

Page 14: DynamicFxPortfolios

G10 1-Month Yields

Series DescriptionEUR001M CURNCY EUR 1 MTH YIELDSUS0001M CURNCY USD 1 MTH YIELDSJY0001M CURNCY JPY 1 MTH YIELDSBP0001M CURNCY GBP 1 MTH YIELDSSF0001M CURNCY CHF 1 MTH YIELDSCDOR01 CURNCY CAD 1 MTH YIELDSBBSW1M CURNCY AUD 1 MTH YIELDSNFIX1M CURNCY NZD 1 MTH YIELDS

NIBOR1M CURNCY NOK 1 MTH YIELDSSTIB1M CURNCY SEK 1 MTH YIELDS

Table: G10 1-Month Yield DataOverview (source: Bloomberg)

G10 1-Month Yield Data

EU

R00

1M_C

UR

NC

Y

12

34

5

US

0001

M_C

UR

NC

Y

02

46

810

JY00

01M

_CU

RN

CY

02

46

8

BP

0001

M_C

UR

NC

Y

510

150

24

68

10

SF

0001

M_C

UR

NC

Y

1980 1985 1990 1995 2000 2005 2010

CD

OR

01_C

UR

NC

Y

24

68

BB

SW

1M_C

UR

NC

Y

510

15

NF

IX1M

_CU

RN

CY

46

810

12

NIB

OR

1M_C

UR

NC

Y

010

3050

020

4060

ST

IB1M

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

1M Yield Data

Page 15: DynamicFxPortfolios

G10 FX Rates

Series DescriptionUSDEUR CURNCY USDEUR FX RATEJPYEUR CURNCY JPYEUR FX RATEGBPEUR CURNCY GBPEUR FX RATECHFEUR CURNCY CHFEUR FX RATECADEUR CURNCY CADEUR FX RATEAUDEUR CURNCY AUDEUR FX RATENZDEUR CURNCY NZDEUR FX RATENOKEUR CURNCY NOKEUR FX RATESEKEUR CURNCY SEKEUR FX RATE

Table: G10 FX Rates Overview(source: Bloomberg, Datastream)

G10 Foreign Exchange Rate Data

US

DE

UR

_CU

RN

CY

0.6

1.0

1.4

JPY

EU

R_C

UR

NC

Y

0.00

40.

008

GB

PE

UR

_CU

RN

CY

1.1

1.3

1.5

1.7

CH

FE

UR

_CU

RN

CY

0.35

0.50

0.65

0.5

0.7

0.9

CA

DE

UR

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

AU

DE

UR

_CU

RN

CY

0.5

0.7

0.9

1.1

NZ

DE

UR

_CU

RN

CY

0.4

0.5

0.6

0.7

NO

KE

UR

_CU

RN

CY

0.10

0.12

0.14

0.10

0.14

SE

KE

UR

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

EUR FX RATES

Page 16: DynamicFxPortfolios

Calculating the G10 FX Carry and Momentum ReturnIndices

We build weekly carry and momentum return indices byconstructing FX portfolios following the ranking procedure adoptedby e.g. Vesilind [10] and Hochradl and Wagner [6]:

Asset Allocation Procedure

1 Rank the G10 currencies according to their yield (Carry) or52-period z-Score (Momentum).

2 Buy the 30% highest ranking currencies and fund thesepositions by selling the 30% lowest ranking currencies.

3 Hold the FX portfolio for one period.

We apply a spread of 10 basis points on fixed income positions, a spread of 0.03% on FX trades and slippage costs

of 0.02% on FX trades.

Page 17: DynamicFxPortfolios

Asset Allocation Procedure: G10 Carry Portfolio

G10 Yields

010

2030

4050

60

1980 1985 1990 1995 2000 2005 2010

G10 Yields

010

2030

4050

60

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

EUR001M_CURNCYUS0001M_CURNCYJY0001M_CURNCYBP0001M_CURNCYSF0001M_CURNCYCDOR01_CURNCYBBSW1M_CURNCYNFIX1M_CURNCYNIBOR1M_CURNCYSTIB1M_CURNCY

Ranked G10 Yields

EU

R00

1M_C

UR

NC

Y

02

46

810

US

0001

M_C

UR

NC

Y

02

46

810

JY00

01M

_CU

RN

CY

02

46

810

BP

0001

M_C

UR

NC

Y

02

46

810

02

46

810

SF

0001

M_C

UR

NC

Y

1980 1985 1990 1995 2000 2005 2010

CD

OR

01_C

UR

NC

Y

02

46

810

BB

SW

1M_C

UR

NC

Y

02

46

810

NF

IX1M

_CU

RN

CY

02

46

810

NIB

OR

1M_C

UR

NC

Y

02

46

810

02

46

810

ST

IB1M

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

Ranked G10 Yields

Page 18: DynamicFxPortfolios

Asset Allocation Procedure: G10 Carry Portfolio

G10 Yields

010

2030

4050

60

1980 1985 1990 1995 2000 2005 2010

G10 Yields

010

2030

4050

60

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

EUR001M_CURNCYUS0001M_CURNCYJY0001M_CURNCYBP0001M_CURNCYSF0001M_CURNCYCDOR01_CURNCYBBSW1M_CURNCYNFIX1M_CURNCYNIBOR1M_CURNCYSTIB1M_CURNCY

G10 Carry Portfolio Positions

EU

R00

1M_C

UR

NC

Y

−1.

00.

00.

51.

0

US

0001

M_C

UR

NC

Y

−1.

00.

00.

51.

0

JY00

01M

_CU

RN

CY

−1.

00.

00.

51.

0

BP

0001

M_C

UR

NC

Y

−1.

00.

00.

51.

0−

1.0

0.0

0.5

1.0

SF

0001

M_C

UR

NC

Y

1980 1985 1990 1995 2000 2005 2010

CD

OR

01_C

UR

NC

Y

−1.

00.

00.

51.

0

BB

SW

1M_C

UR

NC

Y

−1.

00.

00.

51.

0

NF

IX1M

_CU

RN

CY

−1.

00.

00.

51.

0

NIB

OR

1M_C

UR

NC

Y

−1.

00.

00.

51.

0−

1.0

0.0

0.5

1.0

ST

IB1M

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

Portfolio Positions:G10 Carry Ranker

Page 19: DynamicFxPortfolios

Returns to the Long-Only G10 Carry Portfolio

G10 Carry Portfolio Performance

100

150

200

250

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Carry Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Carry Portfolio

market position Longmarket position Short

0.0

0.5

1.0

1.5

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Carry Portfolio

0.0

0.5

1.0

1.5

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

G10 Carry Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Carry Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

20.

00.

20.

4

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Carry Portfolio

−0.

20.

00.

20.

4

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

−0.

10.

10.

30.

5

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

−0.

10.

10.

30.

5

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 20: DynamicFxPortfolios

Asset Allocation Procedure: G10 Momentum Portfolio

USD Cash Returns

0.6

0.8

1.0

1.2

1.4

1980 1985 1990 1995 2000 2005 2010

Asset: Cash USD 1M

02

46

810

Index

as.z

oo(x

)

USDEUR_CURNCY (left axis)US0001M_CURNCY (right axis)

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: CASH USD

market position Longmarket position Short

−0.

50.

00.

51.

0

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: CASH USD

−0.

50.

00.

51.

0

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

USD Momentum

−3

−2

−1

01

23

1980 1985 1990 1995 2000 2005 2010

USD Total Returns and USD Momentum

−0.

20.

00.

20.

40.

60.

8

as.z

oo(x

)

USD Momentum (left axis)USD Returns (right axis)

Page 21: DynamicFxPortfolios

Asset Allocation Procedure: G10 Momentum Portfolio

G10 Momentum

−4

−2

02

4

1980 1985 1990 1995 2000 2005 2010

G10 Momentum

−4

−2

02

4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Ranked G10 Momentum

CA

SH

EU

R

02

46

810

CA

SH

US

D

02

46

810

CA

SH

JP

Y

02

46

810

CA

SH

GB

P

02

46

810

02

46

810

CA

SH

CH

F

1980 1985 1990 1995 2000 2005 2010

CA

SH

CA

D

02

46

810

CA

SH

AU

D

02

46

810

CA

SH

NZ

D

02

46

810

CA

SH

NO

K

02

46

810

02

46

810

CA

SH

SE

K

1980 1985 1990 1995 2000 2005 2010

Ranked G10 Momentum

Page 22: DynamicFxPortfolios

Asset Allocation Procedure: G10 Momentum Portfolio

G10 Momentum

−4

−2

02

4

1980 1985 1990 1995 2000 2005 2010

G10 Momentum

−4

−2

02

4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

G10 Momentum Portfolio Positions

CA

SH

EU

R

−1.

00.

00.

51.

0

CA

SH

US

D

−1.

00.

00.

51.

0

CA

SH

JP

Y

−1.

00.

00.

51.

0

CA

SH

GB

P

−1.

00.

00.

51.

0−

1.0

0.0

0.5

1.0

CA

SH

CH

F

1980 1985 1990 1995 2000 2005 2010

CA

SH

CA

D

−1.

00.

00.

51.

0

CA

SH

AU

D

−1.

00.

00.

51.

0

CA

SH

NZ

D

−1.

00.

00.

51.

0

CA

SH

NO

K

−1.

00.

00.

51.

0−

1.0

0.0

0.5

1.0

CA

SH

SE

K

1980 1985 1990 1995 2000 2005 2010

Portfolio Positions:G10 Momentum Ranker

Page 23: DynamicFxPortfolios

Returns to the Long-Only G10 Momentum Portfolio

G10 Momentum Portfolio Performance

100

120

140

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Momentum Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Momentum Portfolio

market position Longmarket position Short

−0.

20.

00.

20.

4

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Momentum Portfolio

−0.

20.

00.

20.

4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

G10 Momentum Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Momentum Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

20.

00.

10.

2

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Momentum Portfolio

−0.

20.

00.

10.

2

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

2−

0.1

0.0

0.1

0.2

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

2−

0.1

0.0

0.1

0.2

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 24: DynamicFxPortfolios

Carry and Momentum Returns

FX Carry and Momentum Indices

100

150

200

250

1980 1985 1990 1995 2000 2005 2010

FX Carry Index Perfromancevs. FX Momentum Index Perfromance

FX Carry IndexFX Momentum Index

−0.

10−

0.05

0.00

0.05

1980 1985 1990 1995 2000 2005 2010

FX Carry Total Returns

Carry Returns

−0.

050.

000.

050.

10

1980 1985 1990 1995 2000 2005 2010

FX Momentum Total Returns

Momentum Returns

FX Carry and Momentum Correlation

−0.10 −0.05 0.00 0.05

−0.

050.

000.

050.

10

Scatterplot: FX Carry Total Returns vs. FX Momentum Total Returns

Momentum Returns

Car

ry R

etur

ns

●●

●●

●●

●●

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● ●●

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−0.10 −0.05 0.00 0.05

−0.

050.

000.

050.

10

Scatterplot: FX Carry Total Returns vs. FX Momentum Total Returns

Momentum Returns

Car

ry R

etur

ns

Correlation: 0.03

Page 25: DynamicFxPortfolios

Risk Indicator: Equity Volatility Component

Equity Risk Timeseries

VIX

_IN

DE

X

1030

5070

1020

3040

5060

VD

AX

_IN

DE

X

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Equity Volatility

Normalized Equity Volatility Timeseries

z−sc

ore:

VIX

_IN

DE

X

−2

02

4−

20

24

z−sc

ore:

VD

AX

_IN

DE

X1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Equity Volatility

Page 26: DynamicFxPortfolios

Risk Indicator: Equity Volatility Component

Equity Volatility Timeseries

VIX

_IN

DE

X

1030

5070

1020

3040

5060

VD

AX

_IN

DE

X

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Equity Volatility

Equity Volatility Risk Indicator Component

−2

02

4

1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Equity Volatility

−2

02

4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

z−score: VIX_INDEXz−score: VDAX_INDEXRisk Indicator: Equity Vola Component

Page 27: DynamicFxPortfolios

Risk Indicator: Equity Positioning Component

Equity Positioning Timeseries

MS

CI G

row

th/V

alue

Inde

x

−0.

6−

0.4

−0.

20.

00.

00.

51.

01.

5

MS

CI D

efen

sive

s/C

yclic

als

Inde

x

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Equity Market Positioning

Normalized Equity Positioning Timeseries

z−sc

ore:

MS

CI G

row

th/V

alue

Inde

x

−3

−1

01

23

4−

20

24

z−sc

ore:

MS

CI D

efen

sive

s/C

yclic

als

Inde

x1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Equity Market Positioning

Page 28: DynamicFxPortfolios

Risk Indicator: Equity Positioning Component

Equity Positioning Timeseries

MS

CI G

row

th/V

alue

Inde

x

−0.

6−

0.4

−0.

20.

00.

00.

51.

01.

5

MS

CI D

efen

sive

s/C

yclic

als

Inde

x

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Equity Market Positioning

Equity Positioning Risk Indicator Component

−2

02

4

1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Equity Market Positioning

−2

02

4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

z−score: MSCI Growth/Value Indexz−score: MSCI Defensives/Cyclicals IndexRisk Indicator: Equity Posi Component

Page 29: DynamicFxPortfolios

Risk Indicator: FX Volatility Component

FX Volatility Timeseries

JPM

VX

YG

7_IN

DE

X

1015

2010

1520

2530

JPM

VX

YE

M_I

ND

EX

1980 1985 1990 1995 2000 2005 2010

Risk Factors: FX Volatility

Normalized FX Volatility Timeseries

z−sc

ore:

JP

MV

XY

G7_

IND

EX

−2

02

4−

20

24

6

z−sc

ore:

JP

MV

XY

EM

_IN

DE

X1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: FX Volatility

Page 30: DynamicFxPortfolios

Risk Indicator: FX Volatility Component

FX Volatility Timeseries

JPM

VX

YG

7_IN

DE

X

1015

2010

1520

2530

JPM

VX

YE

M_I

ND

EX

1980 1985 1990 1995 2000 2005 2010

Risk Factors: FX Volatility

FX Volatility Risk Indicator Component

−2

02

46

1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: FX Volatility

−2

02

46

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

z−score: JPMVXYG7_INDEXz−score: JPMVXYEM_INDEXRisk Indicator: FX Vola Component

Page 31: DynamicFxPortfolios

Risk Indicator: Yield and Credit Component

Yield and Credit Timeseries

US

SP

2_C

MP

L_C

UR

NC

Y

2060

100

140

US

SP

10_C

MP

L_C

UR

NC

Y

2060

100

.TE

DS

P_I

ND

EX

01

23

41

23

45

6

usa

cred

it sp

read

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Yield and Credit Conditions

Normalized Yield and Credit Timeseries

z−sc

ore:

US

SP

2_C

MP

L_C

UR

NC

Y

−2

02

4

z−sc

ore:

US

SP

10_C

MP

L_C

UR

NC

Y

−4

−2

02

4

z−sc

ore:

.TE

DS

P_I

ND

EX

−2

02

4−

20

24

z−sc

ore:

usa

cre

dit s

prea

d

1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Yield and Credit Conditions

Page 32: DynamicFxPortfolios

Risk Indicator: Yield and Credit Component

Yield and Credit Timeseries

US

SP

2_C

MP

L_C

UR

NC

Y

2060

100

140

US

SP

10_C

MP

L_C

UR

NC

Y

2060

100

.TE

DS

P_I

ND

EX

01

23

41

23

45

6

usa

cred

it sp

read

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Yield and Credit Conditions

Yield and Credit Risk Indicator Component

−4

−2

02

4

1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Yield and Credit Conditions

−4

−2

02

4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

z−score: USSP2_CMPL_CURNCYz−score: USSP10_CMPL_CURNCYz−score: .TEDSP_INDEXz−score: usa credit spreadRisk Indicator: Yield and Credit Component

Page 33: DynamicFxPortfolios

Risk Indicator: Safe Haven Component

Safe Haven Timeseries

GO

LDS

_IN

DE

X

400

600

800

1000

0.4

0.6

0.8

1.0

CH

FU

SD

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Safe Haven Assets

Normalized Safe Haven Timeseries

z−sc

ore:

GO

LDS

_IN

DE

X

−2

02

4−

3−

2−

10

12

3

z−sc

ore:

CH

FU

SD

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Safe Haven Assets

Page 34: DynamicFxPortfolios

Risk Indicator: Safe Haven Component

Safe Haven Timeseries

GO

LDS

_IN

DE

X

400

600

800

1000

0.4

0.6

0.8

1.0

CH

FU

SD

_CU

RN

CY

1980 1985 1990 1995 2000 2005 2010

Risk Factors: Safe Haven Assets

Safe Haven Risk Indicator Component

−2

02

4

1980 1985 1990 1995 2000 2005 2010

Normalized Risk Factors: Safe Haven Assets

−2

02

4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

z−score: GOLDS_INDEXz−score: CHFUSD_CURNCYRisk Indicator: Safe Haven Component

Page 35: DynamicFxPortfolios

Aggregated Risk Indicator

Risk Indicator Timeseries

−2

02

46

1980 1985 1990 1995 2000 2005 2010

Risk Indicator & Subcomponents

−2

02

46

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

Risk Indicator: Equity Vola ComponentRisk Indicator: Equity Vola ComponentRisk Indicator: Equity Posi ComponentRisk Indicator: FX Vola ComponentRisk Indicator: Yield and Credit ComponentRisk Indicator: Safe Haven Componentrisk indicator value

We calculate the aggregated RiskIndicator by equally weightingthe 5 sub-components:

Equity Volatility

Equity Positioning

FX Volatility

Yield and Credit

Safe Haven

Page 36: DynamicFxPortfolios

Aggregated Risk Indicator

The Aggregated Risk Indicator

−3

−2

−1

01

23

1980 1985 1990 1995 2000 2005 2010

Aggregated Risk Indicator

risk indicator value

We will use the aggregated RiskIndicator as a measure forrisk-appetite (low indicatorvalues) and risk-aversion (highindicator values) in the markets.

Page 37: DynamicFxPortfolios

Outline

1 Introduction

2 Methodology

3 Data

4 Benchmark Market Timing RulesMoving-Average Crossover RuleRisk-Indicator Filter RuleMoving Average Crossover/Risk-Indicator Combination

5 Conclusion

6 References

Page 38: DynamicFxPortfolios

Timing the Carry Trade with a Moving Average CrossoverRule

Moving Average Crossover Signal

100

150

200

250

1980 1985 1990 1995 2000 2005 2010

TradRule1: Moving Average Crossover (1,52)

100

150

200

250

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

FX Carry IndextsRollMean(FX Carry Index,1)tsRollMean(FX Carry Index,52)

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

Trading Signal

SignalPositions_EntriesExits LongSignalPositions_EntriesExits Short

0.0

0.2

0.4

0.6

0.8

1.0

1980 1985 1990 1995 2000 2005 2010

Market Entry/Exit Signals

0.0

0.2

0.4

0.6

0.8

1.0

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

entry longexit longentry shortexit short

We create a simple Carry timingindicator, following standardmoving average crossover tradingrules:

Entry Long when the FXCarry Index crosses over the52-period moving average.

Entry Short when the FXCarry Index crosses underthe 52-period movingaverage.

Page 39: DynamicFxPortfolios

Timing the FX Carry Trade with a Moving AverageCrossover Rule

Timed FX Carry Portfolio

100

150

200

250

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Carry Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Carry Portfolio

market position Longmarket position Short

0.0

0.4

0.8

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Carry Portfolio

0.0

0.4

0.8

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

Timed FX Carry Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Carry Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

20.

00.

20.

4

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Carry Portfolio

−0.

20.

00.

20.

4

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

0.0

0.1

0.2

0.3

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

0.0

0.1

0.2

0.3

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 40: DynamicFxPortfolios

Timing the FX Momentum Trade with a Moving AverageCrossover Rule

Moving Average Crossover Signal

100

120

140

1980 1985 1990 1995 2000 2005 2010

TradRule1: Moving Average Crossover (1,52)

100

120

140

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

FX Momentum IndextsRollMean(FX Momentum Index,1)tsRollMean(FX Momentum Index,52)

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

Trading Signal

SignalPositions_EntriesExits LongSignalPositions_EntriesExits Short

0.0

0.2

0.4

0.6

0.8

1.0

1980 1985 1990 1995 2000 2005 2010

Market Entry/Exit Signals

0.0

0.2

0.4

0.6

0.8

1.0

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

entry longexit longentry shortexit short

We create a simple Momentumtiming indicator, followingstandard moving averagecrossover trading rules:

Entry Long when the FXMomentum Index crossesover the 52-period movingaverage.

Entry Short when the FXMomentum Index crossesunder the 52-period movingaverage.

Page 41: DynamicFxPortfolios

Timing the FX Momentum Trade with a Moving AverageCrossover Rule

Timed FX Momentum Portfolio

100

120

140

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Momentum Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Momentum Portfolio

market position Longmarket position Short

−0.

6−

0.4

−0.

20.

0

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Momentum Portfolio

−0.

6−

0.4

−0.

20.

0

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

Timed FX Momentum Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Momentum Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

4−

0.2

0.0

0.2

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Momentum Portfolio

−0.

4−

0.2

0.0

0.2

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

5−

0.3

−0.

10.

1

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

5−

0.3

−0.

10.

1 CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 42: DynamicFxPortfolios

Timing the FX Carry Trade with a Risk Indicator FilterRule

Risk Indicator Signal

−3

−2

−1

01

23

1980 1985 1990 1995 2000 2005 2010

TradRule1: Risk Indicator Filter

−3

−2

−1

01

23

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

Risk−Appetite Indicatorthreshold line: 0

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

Trading Signal

SignalPositions_EntriesExits LongSignalPositions_EntriesExits Short

0.0

0.2

0.4

0.6

0.8

1.0

1980 1985 1990 1995 2000 2005 2010

Market Entry/Exit Signals

0.0

0.2

0.4

0.6

0.8

1.0

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

entry longexit longentry shortexit short

We create a Risk-Indicator basedCarry timing indicator, followingthe following trading rules:

Entry Long when theRisk-Appetite Indicatorcrosses over the zero-line.

Entry Short when theRisk-Appetite Indicatorcrosses under the zero-line.

Page 43: DynamicFxPortfolios

Timing the FX Carry Trade with a Risk Indicator FilterRule

Timed FX Carry Portfolio

100

150

200

250

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Carry Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Carry Portfolio

market position Longmarket position Short

−0.

4−

0.2

0.0

0.2

0.4

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Carry Portfolio

−0.

4−

0.2

0.0

0.2

0.4

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

Timed FX Carry Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Carry Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

4−

0.2

0.0

0.2

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Carry Portfolio

−0.

4−

0.2

0.0

0.2

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

−0.

2−

0.1

0.0

0.1

0.2

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

−0.

2−

0.1

0.0

0.1

0.2

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 44: DynamicFxPortfolios

Timing the FX Momentum Trade with a Risk IndicatorFilter Rule

Risk Indicator Signal

−3

−2

−1

01

23

1980 1985 1990 1995 2000 2005 2010

TradRule1: Risk Indicator Filter

−3

−2

−1

01

23

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

Risk−Appetite Indicatorthreshold line: 0

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

Trading Signal

SignalPositions_EntriesExits LongSignalPositions_EntriesExits Short

0.0

0.2

0.4

0.6

0.8

1.0

1980 1985 1990 1995 2000 2005 2010

Market Entry/Exit Signals

0.0

0.2

0.4

0.6

0.8

1.0

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

entry longexit longentry shortexit short

We create a Risk-Indicator basedMomentum timing indicator,following the following tradingrules:

Entry Long when theRisk-Appetite Indicatorcrosses over the zero-line.

Entry Short when theRisk-Appetite Indicatorcrosses under the zero-line.

Page 45: DynamicFxPortfolios

Timing the FX Momentum Trade with a Risk IndicatorFilter Rule

Timed FX Momentum Portfolio

100

120

140

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Momentum Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Momentum Portfolio

market position Longmarket position Short

−0.

40.

00.

20.

40.

6

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Momentum Portfolio

−0.

40.

00.

20.

40.

6

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

Timed FX Momentum Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Momentum Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

3−

0.1

0.1

0.2

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Momentum Portfolio

−0.

3−

0.1

0.1

0.2

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

20.

00.

10.

2

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

20.

00.

10.

2CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 46: DynamicFxPortfolios

Timing the FX Carry Trade with a combined MovingAverage/Risk Appetite Signal

Combined Moving Average/Risk Appetite Signal

0.6

1.0

1.4

1980 1985 1990 1995 2000 2005 2010

Position Signal: Aggregated Strategy Signal

position

−1.

00.

01.

0

1980 1985 1990 1995 2000 2005 2010

Position Signal: Moving Average Crossover (1,52)

position

−1.

00.

01.

0

1980 1985 1990 1995 2000 2005 2010

Filter Signal: Risk Indicator Filter

filter

−1.

00.

01.

0

1980 1985 1990 1995 2000 2005 2010

Aggregated Strategy Signal

market position

−2

02

1980 1985 1990 1995 2000 2005 2010

Strategy Trades

buysell

Trading Rules:

Long When the MovingAverage Rule AND theRisk-Indicator rule are long.

Short When the MovingAverage Rule AND theRisk-Indicator rule are short.

Page 47: DynamicFxPortfolios

Timing the FX Carry Trade with a combined MovingAverage/Risk Appetite Signal

Timed FX Carry Portfolio

100

150

200

250

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Carry Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Carry Portfolio

market position Longmarket position Short

0.0

0.2

0.4

0.6

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Carry Portfolio

0.0

0.2

0.4

0.6

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

Timed FX Carry Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Carry Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

3−

0.1

0.0

0.1

0.2

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Carry Portfolio

−0.

3−

0.1

0.0

0.1

0.2

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

−0.

050.

050.

15

Performance Attribution: G10 Carry Portfolio @ 2009−05−15

−0.

050.

050.

15CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 48: DynamicFxPortfolios

Timing the FX Momentum Trade with a combined MovingAverage/Risk Appetite Signal

Combined Moving Average/Risk Appetite Signal

0.6

1.0

1.4

1980 1985 1990 1995 2000 2005 2010

Position Signal: Aggregated Strategy Signal

position

−1.

00.

01.

0

1980 1985 1990 1995 2000 2005 2010

Position Signal: Moving Average Crossover (1,52)

position

−1.

00.

01.

0

1980 1985 1990 1995 2000 2005 2010

Filter Signal: Risk Indicator Filter

filter

−1.

00.

01.

0

1980 1985 1990 1995 2000 2005 2010

Aggregated Strategy Signal

market position

−2

02

1980 1985 1990 1995 2000 2005 2010

Strategy Trades

buysell

Trading Rules:

Long When the MovingAverage Rule AND theRisk-Indicator rule are long.

Short When the MovingAverage Rule AND theRisk-Indicator rule are short.

Page 49: DynamicFxPortfolios

Timing the FX Momentum Trade with a combined MovingAverage/Risk Appetite Signal

Timed FX Momentum Portfolio

100

120

140

1980 1985 1990 1995 2000 2005 2010

RoI Index of: G10 Momentum Portfolio

Strategy RoI Index

−1.

0−

0.5

0.0

0.5

1.0

1980 1985 1990 1995 2000 2005 2010

TradingStrategy: G10 Momentum Portfolio

market position Longmarket position Short

−0.

3−

0.1

0.1

0.3

1980 1985 1990 1995 2000 2005 2010

StrategyReturns: G10 Momentum Portfolio

−0.

3−

0.1

0.1

0.3

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

fxyieldtransactionsslippagetotal

Timed FX Momentum Portfolio Components

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

Components Positions: G10 Momentum Portfolio

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07

−1.

0−

0.5

0.0

0.5

1.0

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

−0.

3−

0.1

0.1

1980 1985 1990 1995 2000 2005 2010

Portfolio Components StrategyReturns: G10 Momentum Portfolio

−0.

3−

0.1

0.1

Index

as.z

oo(x

)

1980 1985 1990 1995 2000 2005 2010

CASH EURCASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

4−

0.2

0.0

0.1

Performance Attribution: G10 Momentum Portfolio @ 2009−05−15

−0.

4−

0.2

0.0

0.1 CASH EUR

CASH USDCASH JPYCASH GBPCASH CHFCASH CADCASH AUDCASH NZDCASH NOKCASH SEK

Page 50: DynamicFxPortfolios

Outline

1 Introduction

2 Methodology

3 Data

4 Benchmark Market Timing Rules

5 Conclusion

6 References

Page 51: DynamicFxPortfolios

Dynamic FX Portfolio Trading: Status-Quo

We built a software for backtesting portfolios of tradingsystems.

We tested benchmark FX Carry and Momentum portfoliotiming strategies with mixed results.

The approach of combining different types of market timingrules looks promising.

Next steps: Calculation of the statistical market timingindicators based on risk-factors.

Page 52: DynamicFxPortfolios

Outline

1 Introduction

2 Methodology

3 Data

4 Benchmark Market Timing Rules

5 Conclusion

6 References

Page 53: DynamicFxPortfolios

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Virginie Coudert and Mathieu Gex.Can risk aversion indicators anticipate financial crises?Technical Report 9, Banque de France, December 2006.

Christian L. Dunis and Jia Miao.Trading foreign exchange portfolios with volatility filters: thecarry model revisited.Applied Financial Economics, 17(3):249–255, 2007.

Alex Heath, Christian Upper, Paola Gallardo, Philippe Mesny,and Carlos Mallo.

Page 54: DynamicFxPortfolios

Triennial Central Bank Survey.Bank for International Settlements, 2007.

Markus Hochradl and Christian Wagner.Trading the forward bias: Are there limits to speculation?SSRN eLibrary, 2007.

P. Lequeux and E. Acar.A dynamic index for managed currencies funds using cmecurrency contracts.European Journal of Finance, 4(4):311–330, 1998.

Jia Miao and Christian L. Dunis.Volatility filters for fx portfolios trading: the impact ofalternative volatility models.Applied Financial Economics Letters, 2(6):389–394, 2006.

Darren Read, William Darwin, and Pauline O’Neill.Measuring equity market risk.Technical report, UBS Investment Research, Global EquityStrategy, June 2006.

Page 55: DynamicFxPortfolios

Andres Vesilind.Profitability of simple trading strategies exploiting the forwardpremium bias in foreign exchange markets and the timepremium in yield curves.Technical Report 2006-04, Oct 2006.