Background and Context
Research Focus
This study extends the basis-momentum strategy from commodity markets to foreign exchange markets for the first time.
Market Significance
Currency markets are the world's largest financial markets with $6.6 trillion in daily trading volume.
Methodology
Analysis covers 48 currencies from 1983-2020 using quintile portfolio sorting and novel signal decomposition methods.
Basis-Momentum Strategy Concept in Currency Markets
- Basis-momentum compares momentum returns between first and second-nearby forward currency contracts.
- Strategy exploits information from the term structure and slope of forward curves.
- Novel application extends successful commodity market strategy to foreign exchange markets.
BM-3 Strategy Outperforms Traditional Currency Strategies
- BM-3 strategy with 3-month formation period achieves highest monthly returns of 1.23%.
- BM strategies consistently deliver superior risk-adjusted returns across all formation periods.
- Lower volatility compared to benchmark strategies results in higher Sharpe ratios.
BM Signal Decomposition into Four Key Components
- Novel decomposition model breaks BM signal into four interpretable components with economic meaning.
- Forward discount represents carry trade information while excess return change captures momentum.
- Spot rate change and second forward discount provide additional risk management benefits.
Component Contributions Show Carry and Momentum Drive BM Returns
- Forward discount and excess return change components contribute most to BM strategy returns.
- Adding all four components together creates the complete BM strategy with highest performance.
- Spot rate and second forward discount components enhance risk-adjusted performance through diversification.
BM Performance Varies Significantly Across Economic Periods
- BM strategy shows strongest performance during Euro introduction period from 1999-2010.
- Post-financial crisis performance declines but BM maintains statistical significance unlike momentum.
- Economic shocks like Euro launch and financial crisis significantly impact currency strategy effectiveness.
Contribution and Implications
- First comprehensive analysis of basis-momentum strategies in currency markets with novel decomposition framework.
- Demonstrates BM as distinct risk factor not fully explained by existing carry and momentum strategies.
- Provides superior risk-return profile for currency portfolio managers seeking diversification and lower volatility.
- Evidence supports forward curve information as valuable source of currency return predictability.
Data Sources
- Performance comparison chart constructed from Table 1 showing BM strategy returns across formation periods.
- Component contribution analysis based on Table 3 Panel B multiple component portfolio results.
- Subperiod analysis visualization uses Table 2 data covering three distinct economic periods.
- SVG diagrams illustrate conceptual framework from Section 2 methodology and decomposition equations.
Infographics by Topic
