Semester

Fall

Date of Graduation

2010

Document Type

Dissertation

Degree Type

PhD

College

Chambers College of Business and Economics

Department

Economics

Committee Chair

Ronald J. Balvers.

Abstract

This dissertation contains three essays dealing with current issues in the foreign exchange and equity exchange markets. The first essay observes that both markets display behaviors akin to momentum and mean reversion. This essay implements a trading strategy combining mean reversion and momentum in foreign exchange markets. The strategy was originally designed for equity markets, but it also generates abnormal returns when applied to uncovered interest parity deviations for five countries. I find that the pattern for the positions thus created in the foreign exchange markets is qualitatively similar to that found in the equity markets. Quantitatively, this strategy performs better in foreign exchange markets than in equity markets. Also, it outperforms traditional foreign exchange trading strategies, such as carry trades and moving average rules.;In the second essay, we further examine the strategy combining mean reversion and momentum in the FX market. Our goal is to find it the abnormal returns thus obtained are compensation for risk. We find a striking similarity between the common stock and FX market returns. We analyze different asset pricing models through a variety of econometrical procedures, such as GMM and two-pass approach. When comparing these models, we assert that the Consumption CAPMs are the only ones that can explain the FX returns.;In the third essay, I look at the zero-investment uncovered interest parity (UIP) portfolio positions as perfect factor-mimicking portfolios for currency risk in the International CAPM context. Their returns are the currency risk premia. Since the UIP positions on average provide low returns, the currency risk premia must be low so that currency risk appears not to be priced in an unconditional model. However, previous research has shown that UIP returns are predictable and may be quite substantial conditionally. I use this observation to generate a specific conditional version of the International CAPM. A GMM approach shows that the conditional model performs well, while the unconditional International CAPM is marginal. The paper thus argues that previous rejections of the International CAPM stem from the fact that currency risk premia are by nature low over extended periods of time and do not provide evidence against the International CAPM.

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