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on Market Microstructure |
| By: | Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo |
| Abstract: | Currencies that are at a forward premium tend to depreciate. This `forward-premium puzzle' represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. The first strategy, known as the carry trade, is widely used by practitioners. This strategy involves selling currencies forward that are at a forward premium and buying currencies forward that are at a forward discount. The second strategy relies on a particular regression to forecast the payoff to selling currencies forward. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. However, these Sharpe ratios do not represent unexploited profit opportunities. In the presence of microstructure frictions, spot and forward exchange rates move against traders as they increase their positions. The resulting `price pressure' drives a wedge between average and marginal Sharpe ratios. We argue that marginal Sharpe ratios are zero even though average Sharpe ratios are positive. |
| JEL: | E24 F31 G15 |
| Date: | 2006–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12489&r=mst |
| By: | Ole E. Barndorff-Nielsen; Peter R. Hansen; Asger Lunde; Neil Shephard |
| Abstract: | In a recent paper we have introduced the class of realised kernel estimators of the increments of quadratic variation in the presence of noise. We showed that this estimator is consistent and derived its limit distribution under various assumptions on the kernel weights. In this paper we extend our analysis, looking at the class of subsampled realised kernels and we derive the limit theory for this class of estimators. We find that subsampling is highly advantageous for estimators based on discontinuous kernels, such as the truncated kernel. For kinked kernels, such as the Bartlett kernel, we show that subsampling is impotent, in the sense that subsampling has no effect on the asymptotic distribution. Perhaps surprisingly, for the efficient smooth kernels, such as the Parzen kernel, we show that subsampling is harmful as it increases the asymptotic variance. We also study the performance of subsampled realised kernels in simulations and in empirical work. |
| Keywords: | Bipower variation; Long run variance estimator; Market frictions; Quadratic variation; Realised kernel; Realised variance; Subsampling. |
| JEL: | C13 C22 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:sbs:wpsefe:2006fe06&r=mst |