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A Low-Risk Strategy Based on Higher Moments in Currency Markets Dynamics

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “A Low-Risk Strategy Based on Higher Moments in Currency Markets” offers a groundbreaking exploration into the elusive domain of low-risk anomalies within currency markets.

Claudia Zunft presents pioneering evidence substantiating the existence of a novel strategy in currency forward markets, one that capitalizes on the disparity in higher return moments for long and short positions.

Notably, this strategy defies the conventional span of traditional currency strategies, yielding the highest mean excess payoff, Sharpe ratio, and the smallest drawdown in a comprehensive sample spanning 25 years.

Intriguingly, the profitability of this strategy remains enigmatic, evading explanations through standard risk factors and the constraints of arbitrage. With its discourse on low-risk anomalies, higher moments, currency dynamics, and factor portfolios, this paper opens a gateway to a paradigm shift within currency market paradigms.

Abstract Of Paper

This paper is first to establish profound evidence on the existence of a low-risk anomaly in currency markets. In particular, I discover a novel strategy in currency forward markets that is long in currencies whose higher return moments are low relative to past levels and short in currencies whose higher return moments are high relative to past levels. The low-risk strategy based on higher moments is not spanned by traditional currency strategies. In a sample of roughly 25 years, it provides the highest mean excess payoff and Sharpe ratio as well as the smallest drawdown in comparison to them. The profitability of the strategy is not explained by standard risk factors and limits-to-arbitrage.

Original paper – Download PDF

Here you can download the PDF and original paper of A Low-Risk Strategy Based on Higher Moments in Currency Markets.

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Author

Claudia Zunft
Goethe University Frankfurt – Department of Finance; Quoniam Asset Management GmbH

Conclusion

In conclusion, the study “A Low-Risk Strategy Based on Higher Moments in Currency Markets” stands as a trailblazing testament to the unearthing of a low-risk anomaly within currency markets.

Claudia Zunft’s pioneering research shines a spotlight on the discovery of a novel strategy in currency forward markets, one that strategically capitalizes on the variance of higher return moments.

Notably, this strategy defies the boundaries of traditional currency strategies, culminating in the highest mean excess payoff, Sharpe ratio, and the smallest drawdown over a comprehensive 25-year sample period.

The enigmatic profitability of this strategy, evading interpretation through standard risk factors and arbitrage constraints, collectively underscores the depth of complexity that characterizes the currency markets. With its discourse on low-risk anomalies, higher moments, and factor portfolios, this paper serves as a vanguard, reshaping the contours of low-risk currency strategies.

Related Reading:

Economic Momentum and Currency Returns

Using Option-Implied Information to Improve Currency Carry Trade Profits

FAQ

Q1: What is the key finding of the research paper “A Low-Risk Strategy Based on Higher Moments in Currency Markets”?

A1: The key finding of the research paper is the identification and substantiation of a low-risk anomaly in currency markets. The paper introduces a novel strategy in currency forward markets that strategically takes long positions in currencies with lower return moments relative to past levels and short positions in currencies with higher return moments. This strategy outperforms traditional currency strategies, exhibiting the highest mean excess payoff, Sharpe ratio, and the smallest drawdown over a 25-year sample period.

Q2: How does the low-risk strategy based on higher moments differ from traditional currency strategies, and what makes it stand out in terms of performance?

A2: The low-risk strategy based on higher moments differs from traditional currency strategies by strategically considering the higher return moments of currencies. It outperforms traditional strategies, showcasing superior mean excess payoff, Sharpe ratio, and smaller drawdown over a 25-year sample period. This indicates its effectiveness in navigating currency markets and capitalizing on the identified low-risk anomaly.

Q3: What makes the profitability of the low-risk strategy enigmatic, and how does it challenge standard risk factors and arbitrage constraints?

A3: The profitability of the low-risk strategy remains enigmatic as it defies explanation through standard risk factors and arbitrage constraints. Despite its superior performance, the strategy cannot be easily explained by conventional risk factors, challenging existing paradigms and suggesting a nuanced complexity in the dynamics of currency markets.

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