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Are Value Strategies Profitable in the Foreign Exchange Market?

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Are Value Strategies Profitable in the Foreign Exchange Market?” by Ahmad Raza, traverses the terrain of evaluating the profitability of value strategies hinged on diverse metrics of currency valuation.

It meticulously investigates the efficacy of real exchange rate level strategies, real exchange rate changes, purchasing power parity, and Big-Mac index-based strategies to discern their aptitude in generating excess returns across varying intervals.

Notably, the study ascertains that real exchange rate level strategies wield the propensity to yield substantial excess returns in intervals up to one month, while real exchange rate changes emerge as the front-runners in churning out sizable excess returns over intervals spanning 1-12 months.

Concomitantly, purchasing power parity and Big-Mac index-based strategies fade in comparison, faltering in their ability to deliver commensurate returns. Intriguingly, the study unveils that these returns elude explication from economic state variables or currency risk factors, and notably surpass estimated transaction costs.

Furthermore, a composite strategy amalgamating all four valuation approaches proffers superior mean returns albeit with augmented volatility, attributable to portfolio concentration.

Abstract Of Paper

This paper examines the profitability of value strategies based on four different measures of currency valuation. Real exchange rate level strategies generate the largest excess returns on intervals up to 1 month, while real exchange rate changes produce the largest excess returns for intervals of 1-12 months. Purchasing power parity and Big-Mac index based strategies underperform. The returns are not explained by economic state variables or currency risk factors and are larger than estimated transaction costs. A composite strategy based on all four valuation approaches produces superior mean returns but volatility is also higher due to portfolio concentration.

Original paper – Download PDF

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Author

Ahmad Raza
University of Otago – Department of Accountancy and Finance

Conclusion

In summation, the research paper “Are Value Strategies Profitable in the Foreign Exchange Market?” by Ahmad Raza charts a nuanced exploration into the realm of value strategies, probing their profitability predicated on an array of currency valuation metrics.

The study adeptly unveils the towering potency of real exchange rate level strategies in furnishing substantial excess returns over shorter intervals, juxtaposed against the preeminence of real exchange rate changes in yielding robust excess returns over relatively longer durations.

Augmenting this discernment is the lackluster performance of purchasing power parity and Big-Mac index-based strategies, outshone by their counterparts. Importantly, the study underscores the enigmatic nature of these returns, shirking rationale from economic state variables or currency risk factors, while magnifying the divergence between the returns and estimated transaction costs.

Emphatically, a composite strategy amalgamating all four valuation approaches emerges as the beacon of superior mean returns, albeit accompanied by heightened volatility stemming from portfolio concentration.

In essence, this seminal study ignites fresh insights into the intricacies of value strategies in the foreign exchange market, championing a rich tapestry of findings that confound conventional wisdom while upholding the allure of uncharted dimensions within the currency valuation landscape.

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FAQ

Q1: What is the focus of the research paper “Are Value Strategies Profitable in the Foreign Exchange Market?”?

A1: The research paper evaluates the profitability of value strategies in the foreign exchange market. It explores the efficacy of four different measures of currency valuation: real exchange rate level strategies, real exchange rate changes, purchasing power parity, and Big-Mac index-based strategies. The study aims to discern their ability to generate excess returns over varying time intervals.

Q2: According to the paper, which valuation approach produces the largest excess returns on shorter intervals (up to 1 month)?

A2: The paper indicates that real exchange rate level strategies generate the largest excess returns on intervals up to 1 month.

Q3: What is the outcome of the composite strategy that combines all four valuation approaches?

A3: The composite strategy that amalgamates all four valuation approaches produces superior mean returns. However, it comes with higher volatility attributed to portfolio concentration.

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