Monday, January 28, 2013

International finance


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