Executive Summary
The paper by
Menkhoff, Sarno, Schmeling and Schrimpf (2011) focuses on the different
currency momentum strategies. The main goal of the research is to find out how
the currency momentums are affected by the business cycle risks and other risks
that are inherent in the traditional business, transaction costs and the varied
arbitrage limits. The article is of great importance as it shows that the
momentum properties of the different financial exchange markets are fairly
similar even though it would have been thought that differences could exist due
to the differences in the natures of the stock markets where they are located.
The accessibility of the article would be confined to the relevant finance
experts who would be greatly at ease in understanding the issues that are
raised. Menkhoff et al. also reiterate the findings of a number of other
scholars for instance the lack of relation of liquidity and business cycle
risks with the standard proxies in the FX markets. The findings of the paper
significant act to reinforce the findings of the other others an in some cases
provide reasons as to why those given findings may not have been true. The
different tests that are carried out by Menkhoff et al. are geared towards
increasing the validity of the tests. Further research in the currency momentum
study should consider a number of areas and issues for instance consider the
highly time varied momentum profits and the effect or the impact of the
arbitrage activity.
The article review
is about the ‘Currency Momentum Strategies’ a journal article that was written
by Menkhoff, Sarno, Schmeling and Schrimpf (2011); which is made up of a total
of 89 pages seeks to provide an empirical investigation into the foreign
exchange market momentum strategies especially with regards to the view of the
momentum across the different currencies that are used by the different
countries. The paper focuses mostly on finding the anatomy of the economic momentum
especially the momentum of profits in the financial exchange (FX) markets. The
article considers the viewpoint of the United States investors especially with
regards to the two scenarios where the investor is ether short in currency;
characterized with low past excess returns or where the investor is long in
currency, characterized with high past excess returns. The other goal of the
article by Menkhoff et al. (2011) is with regards to whether the currency
momentums are affected by the business cycle risks and other risks that are
inherent in the traditional business, transaction costs and the varied
arbitrage limits. The article is of great importance as it will play a role in
enhancing the understanding of how the different factors for instance the various
arbitrage limits, business cycle risks and the costs of transactions have an
impact on the currency momentums. The article is also of great importance as it
clearly shows that the momentum properties of the different financial exchange
markets are fairly similar even though it would have been thought that
differences could exist due to the differences in the natures of the stock
markets where they are located. The other significance of the article by
Menkhoff et al. (2011) is with regards too the riskiness of the currency
momentum strategies especially in the short periods of time. However, as a
result of the highly complex nature of the issues that is discussed by the
authors, Menkhoff et al. (2011), the high complex analysis would lead to a
situation where the accessibility of the article would be confined to the
relevant finance experts who would be greatly at ease in understanding the
issues that are raised in the paper especially based on the fact that the
issues would appear somewhat abstract to the people who have little skill
levels in the area of the research.
Menkhoff et al.
(2011) article focuses on the various elements of the momentum returns in the
stock markets through the views of the various risks that are involved. The
paper considers the different forms of data for instance the use of the large
elements of cross country studies that show the time series of the currencies.
The paper considers a variety of other literature that deals with the cross
sectional momentum in the FX markets. The main realization by the authors was
with regards to the fact that the different studies did not provide a unifying
analysis which could aid in the understanding of the cross-sectional returns on
the currency momentums. The paper goes beyond the other research papers that
had been developed in the area of currency momentum strategies to incorporate a
number of issues for instance the quantification of the transaction costs
importance and the examination of the other non standard sources of the
momentum returns, the issue of over or under reaction, arbitrate limits,
analysis of the importance both unsystematic and systematic risks in the
understanding of the momentum returns. The paper notes that the effects of
momentum in different assets share common sources in some cases.
Menkhoff et al.
(2011) also reiterate the findings of a number of other scholars for instance
the lack of relation of liquidity and business cycle risks with the standard
proxies in the FX markets. The article also notes that the high returns on the currency
momentum strategies can be explained through the consideration of the
sensitivities which exist due to the high transaction costs and the existence
of the effective obstacles that constrain the use of arbitrage capital.
Menkhoff et al.
(2011) applies the empirical research which makes use of a longer period of
research and also makes use of a greater cross section of currencies which are
drawn from both developed and developing world. The sample consists of 48
countries and the data extends between January 1976 and January 2010 especially
with reference to 1 month forward exchange rates and spot exchange rates.
The findings of
the paper indicate that the transaction costs can play a significant role in
the understanding of the momentum returns in the foreign exchange and currency
markets. However, since lower excess returns do not result from lower bid-ask
spreads, it can be noted that the transaction costs are not the only driving
force behind the momentum effects (Menkhoff et al. (2011). Secondly, there is
also the view that the business cycle risks and the other portfolio based risks
do not help in the understanding of the momentum returns. Finally, with regards
to the country risks which are a limit of arbitrage, they [the country risks]
are higher for the carry trade target currencies as compared with the rates for
the carry trade funding currencies. The former refer to the currencies which
attract high interest rates while the latter are those that attract low
interest rates.
The section that
follows carries the evaluation and analysis of the methods and the findings.
The paper is carried out objectively especially given the wide review of
literature on the different other authors who had undertaken empirical research
in the previous years. The authors seek to fill the different gaps that have
been left by the other authors whose work have been reviewed in the paper for
instance the extension of the number of years and the numbers of countries that
are used in the analysis that is reported by Menkhoff et al. (2011). The use of
the empirical research coupled with the literature review ensures that the
findings of the research that was carried out by Menkhoff et al. (2011) is
objective and thus is not one sided. Also, the larger cross section and the
greater span of time which is considered in the analysis is to increase the
objectivity of the findings especially in relation to the different exposures
to the varied global risks that are faced in by the different currencies over
time.
The findings of
the paper significant act to reinforce the findings of the other others an in
some cases provide reasons as to why those given findings may not have been
true. The different biases that may have caused the result to be the way they
are discussed in the paper by Menkhoff et al. (2011). With regards to the
effects of the transaction costs in the understanding of the currency markets
momentum returns, the findings of Menkhoff et al. (2011) are in line with the
other authors in the filed for instance those of Burnside et al (2006; 2007). The
results of the tests are used to support the conclusion that is made in the
paper. The authors note that the transaction costs may not be able to fully
explain the momentum returns as was previously viewed, due to the advancement
of the technologies. This explanation is valid due to the fact that there are a
number of technologies which have been employed in the foreign exchange markets
throughout the globe and they have affected the effects of the transaction costs.
Secondly, with regards to the business risks, the findings of the paper play an
instrumental role in helping to explain the US equity momentum, which could
previously not be understood by reliance on the covariance of the different
macro risk factors.
The different
tests that are carried out by Menkhoff et al. (2011) are geared towards
increasing the validity of the tests. It can thus be said that the findings of
the paper are very valid. The tests that are curried out include the tests for
different base currencies which are undertaken through the conversion of the
data that are contained in some currencies to ensure that the results have no
effects on the momentum strategies of profitability.
However due to the
data limitations especially with regards to the risk factors that are
considered in the analysis, it can be said that the results may not be
applicable to all countries and all currencies. In the face of the above, the
focus by Menkhoff et al. (2011) was to focus of the capture of the broad economic
conditions thus ensuring that the results could be applied sparingly. The
realization of the limitation ensures that Menkhoff et al. (2011) does not
mislead the various readers of the report.
The scholarly
value of the paper by Menkhoff et al. (2011) can be considered as worthy
especially in relation to the findings. The findings can be used by both
academics and industry players’ for instance financial managers. The paper
informs the readers that the currency momentum in the currency markets is similar
to the situation that they have been used to in the equity markets. The
investors can also make use of the report as it indicates that the minor
currencies have a greater currency momentum due to the transactional costs that
are relatively high. The hedge fund managers and proprietary traders who have
short term horizons in their investments will be informed of the obstacle to
arbitrate that occurs in the FX markets especially due to the momentum profits
that greatly vary with time.
Further research
in the currency momentum study should consider a number of areas and issues.
First, further research should consider the highly time varied momentum profits
and the effect or the impact of the arbitrage activity. This will play a
significantly role in helping the different short term investors to consider
effectively whether the currency momentum would return significant profits on
their investments. Secondly, what is the effect of the setting up of trading
positions in the different currencies on the concentration of the minor or
small currencies in the currency momentum portfolio? The above research
considerations have been raised by the work of Menkhoff et al. (2011).
Bibliography
Menkhoff, L, Sarno, L, Schmeling, M
and Schrimpf, A 2011, ‘Currency Momentum Strategies’, BIS Working Papers No 366, 1-89
