Dynamic FX Portfolios

Dynamic Trading of FX Carry and Momentum
Portfolios
Lorenzo Bertolini
Cass Business School, City University, London
June 6, 2009
1 Introduction
2 Methodology
3 Data
G10 FX and Yield Data
G10 FX Carry and Momentum Indices
Risk-Factors & Risk Indicator
4 Benchmark Market Timing Rules

Moving-Average Crossover Rule
Risk-Indicator Filter Rule
Moving Average Crossover/Risk-Indicator Combination
5 Conclusion
6 References
Outline
1 Introduction
2 Methodology
3 Data
5 Conclusion
6 References
What is Carry and Momentum Trading?
Definition: Carry Trading
A strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to
purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the
difference between the rates, which can often be substantial, depending on the amount of leverage the investor
chooses to use.
source: http://www.investopedia.com/terms/c/currencycarrytrade.asp
Definition: Momentum Trading
An investment strategy that aims to capitalize on the continuance of existing trends in the market. The
momentum investor believes that large increases in the price of a security will be followed by additional gains and
vice versa for declining values.
source: http://www.investopedia.com/terms/m/momentum investing.asp
Carry and Momentum are popular FX Trading Styles
Carry and Momentum trading styles in FX markets are

amongst the most popular trading strategies applied in the
management of FX portfolios (see e.g. Acar [7], BIS-Survey
2007 [5]).
There is evidence for positive returns from trading these two
investment styles (see e.g. Acar [7], Dunis [8], [4] and
Hochradl and Wagner et.al [6]).
Carry and Momentum strategies can incur periods of severe
drawdowns (see e.g. Dunis [8]).
Factors driving FX Carry and Momentum Returns
Our research builds on three main directions in literature, which study the relationship between FX Carry and
Momentum strategy returns and risk-factors:
Timing FX Carry/Momentum with RiskMetrics Volatility Estimates
Dunis [4] ,[8] finds that during periods of low FX market volatility FX Carry and Momentum trading strategies
perform better than they do during periods of high FX market volatility.
Relationship of FX Carry portfolios with risk-factors and monetary variables
Burnside et al. [1] examined the relationship between FX Carry trading returns and risk-related and monetary
timeseries. They found no evidence for a linear relationship on a monthly timeframe.
Risk-Factors as Inputs for Market Timing Indicators
Coudert [3] calculates logistic-regression based early warning indicators with risk-factors as inputs. He achieved
good results when predicting equity market crises and poor results when predicting currency crises.
Addressed Research Questions
Question 1
Do risk-factors allow to forecast periods of profitable FX Carry

and/or Momentum trading?
Question 2
Do more advanced statistical models outperform simple market

timing rules?
Question 3
Do nonlinear neural network based modeling techniques add value

to the market timing process, thereby indicating nonlinear
relationships between FX Carry/Momentum Indices and
risk-factors?
Outline
1 Introduction
2 Methodology
3 Data
5 Conclusion
6 References
Simple Market Timing Benchmarks
We will test three simple market timing models and use them as
benchmarks for the more advanced statistical techniques:
Benchmark Market Timing Models
Simple Moving-Average Crossover Rule

Combined Moving-Average Crossover/Risk-Indicator Rule
Statistical Classification Techniques
Several studies have reported enhanced predictability of signs of

returns versus magnitudes of returns (see e.g. Christoffersen and
Diebold [2]). Building on these results we will attempt to classify
periods with positive FX Carry/Momentum returns and periods
with negative FX Carry/Momentum returns.
Adopted Classification Methods
k-Nearest Neighbors
Logistic Regression
Multi Layer Perceptron Neural Networks
Recurrent Neural Networks
Outline
1 Introduction
2 Methodology
3 Data
5 Conclusion
6 References
Data Overview
We collected data at a weekly frequency from Bloomberg and Datastream. The categories of our data series are:
This data is used for the FX portfolio backtesting routines needed to test dynamic portfolio strategies with timing
indicators.
For the construction of the FX portfolio timing models, we need to construct FX Carry and FX Momentum indices
and transform their total returns timeseries into binary timeseries.
Financial risk-factors will serve as inputs to the FX portfolio timing models.

G10 1-Week Yields
G10 1-Week Yield Data
1W Yield Data
Series Description
EU0001W INDEX EUR 1 WEEK YIELDS
6
5
CD0001W_INDEX
EU0001W_INDEX
5
4
US0001W INDEX USD 1 WEEK YIELDS
4
3
3
JY0001W INDEX JPY 1 WEEK YIELDS
2
1
8 1
BP0001W INDEX GBP 1 WEEK YIELDS
8
AU0001W_INDEX
US0001W_INDEX
7
6
SF0001W INDEX CHF 1 WEEK YIELDS
6
4
CD0001W INDEX CAD 1 WEEK YIELDS
5
2
4
AU0001W INDEX AUD 1 WEEK YIELDS
103
80 1 2 3 4 5 60
NZ0001W_INDEX
JY0001W_INDEX
NZ0001W INDEX NZD 1 WEEK YIELDS
8
NIBOR1W INDEX NOK 1 WEEK YIELDS
6
4
SK0001W INDEX SEK 1 WEEK YIELDS
150
NIBOR1W_INDEX
BP0001W_INDEX
100
Table: G10 1-Week Yield Data
50
2
60
Overview (source: Bloomberg)
4
SK0001W_INDEX
SF0001W_INDEX
5
3
4
2
3
2
1
1
0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
G10 1-Month Yields
G10 1-Month Yield Data
1M Yield Data
Series Description
EUR001M CURNCY EUR 1 MTH YIELDS
SF0001M_CURNCY BP0001M_CURNCY JY0001M_CURNCY US0001M_CURNCY EUR001M_CURNCY
BBSW1M_CURNCY CDOR01_CURNCY
8
4
6
US0001M CURNCY USD 1 MTH YIELDS
4
JY0001M CURNCY JPY 1 MTH YIELDS
2
10 1
BP0001M CURNCY GBP 1 MTH YIELDS
15
8
SF0001M CURNCY CHF 1 MTH YIELDS
10
CDOR01 CURNCY CAD 1 MTH YIELDS
4
2
5
BBSW1M CURNCY AUD 1 MTH YIELDS
8 0
12
NFIX1M_CURNCY
NFIX1M CURNCY NZD 1 MTH YIELDS
10
6
8
NIBOR1M CURNCY NOK 1 MTH YIELDS
6
2
STIB1M CURNCY SEK 1 MTH YIELDS
50 4
150
NIBOR1M_CURNCY
10
30
Table: G10 1-Month Yield Data
10
600
10
Overview (source: Bloomberg)
STIB1M_CURNCY
8
40
6
4
20
2
0
0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
G10 FX Rates
G10 Foreign Exchange Rate Data
EUR FX RATES
Series Description
1.1
1.4
SEKEUR_CURNCY NOKEUR_CURNCY NZDEUR_CURNCY AUDEUR_CURNCY

USDEUR_CURNCY
USDEUR CURNCY USDEUR FX RATE
0.9
1.0
JPYEUR CURNCY JPYEUR FX RATE
0.7
GBPEUR CURNCY GBPEUR FX RATE
0.5
0.6
JPYEUR_CURNCY
CHFEUR CURNCY CHFEUR FX RATE
0.4 0.5 0.6 0.7

0.008
CADEUR CURNCY CADEUR FX RATE
1.7 0.004
AUDEUR CURNCY AUDEUR FX RATE
NZDEUR CURNCY NZDEUR FX RATE
CADEUR_CURNCY CHFEUR_CURNCY GBPEUR_CURNCY
0.14
1.5
NOKEUR CURNCY NOKEUR FX RATE
0.12
1.3
SEKEUR CURNCY SEKEUR FX RATE
0.65 1.1
0.10
0.14
Table: G10 FX Rates Overview
0.50
0.10
(source: Bloomberg, Datastream)
0.35
1980 1985 1990 1995 2000 2005 2010
0.9
0.7
0.5
1980 1985 1990 1995 2000 2005 2010

Calculating the G10 FX Carry and Momentum Return
Indices
We build weekly carry and momentum return indices by

constructing FX portfolios following the ranking procedure adopted
by e.g. Vesilind [10] and Hochradl and Wagner [6]:
Asset Allocation Procedure
1 Rank the G10 currencies according to their yield (Carry) or

52-period z-Score (Momentum).
2 Buy the 30% highest ranking currencies and fund these
positions by selling the 30% lowest ranking currencies.
3 Hold the FX portfolio for one period.
We apply a spread of 10 basis points on fixed income positions, a spread of 0.03% on FX trades and slippage costs
of 0.02% on FX trades.
Asset Allocation Procedure: G10 Carry Portfolio
G10 Yields Ranked G10 Yields
G10 Yields Ranked G10 Yields
10
10
60
EUR001M_CURNCY
8
US0001M_CURNCY
6
JY0001M_CURNCY
4
BP0001M_CURNCY
2
SF0001M_CURNCY
50
100
100
CDOR01_CURNCY
BBSW1M_CURNCY
8
NFIX1M_CURNCY
6
NIBOR1M_CURNCY
4
40
STIB1M_CURNCY
2
100
100
NFIX1M_CURNCY
8
8
as.zoo(x)
6
30
4
2
2
100
100
NIBOR1M_CURNCY
8
8
20
6
4
4
2
2
100
100
STIB1M_CURNCY
10
8
6
6
4
4
2
2
0
0
0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Asset Allocation Procedure: G10 Carry Portfolio
G10 Yields G10 Carry Portfolio Positions
G10 Yields Portfolio Positions:G10 Carry Ranker
0.0 0.5 1.0
0.0 0.5 1.0

60
EUR001M_CURNCY
US0001M_CURNCY
JY0001M_CURNCY
BP0001M_CURNCY
SF0001M_CURNCY
50
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

CDOR01_CURNCY
BBSW1M_CURNCY
NFIX1M_CURNCY
NIBOR1M_CURNCY
40
STIB1M_CURNCY
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

NFIX1M_CURNCY
as.zoo(x)
30
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

NIBOR1M_CURNCY
20
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

STIB1M_CURNCY
10
−1.0
−1.0
0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Returns to the Long-Only G10 Carry Portfolio
G10 Carry Portfolio Performance G10 Carry Portfolio Components
RoI Index of: G10 Carry Portfolio Components Positions: G10 Carry Portfolio
1.0
250
Strategy RoI Index CASH EUR

CASH USD
0.5
CASH JPY
CASH GBP
200
CASH CHF
0.0
CASH CAD
CASH AUD
150
−0.5
CASH NZD
CASH NOK
CASH SEK
−1.0
100
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
TradingStrategy: G10 Carry Portfolio Portfolio Components StrategyReturns: G10 Carry Portfolio
1.0
market position Long CASH EUR
0.4
market position Short CASH USD
0.5
CASH JPY
CASH GBP
as.zoo(x)
0.2
CASH CHF
0.0
CASH CAD
CASH AUD
0.0
CASH NZD
−0.5
CASH NOK
−0.2
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
StrategyReturns: G10 Carry Portfolio Performance Attribution: G10 Carry Portfolio @ 2009−05−15
0.5
1.5
fx CASH EUR
yield CASH USD
transactions CASH JPY
0.3
1.0
slippage CASH GBP

as.zoo(x)
total CASH CHF

0.1 CASH CAD
0.5
CASH AUD
CASH NZD
CASH NOK
−0.1
CASH SEK
0.0
1980 1985 1990 1995 2000 2005 2010

Asset Allocation Procedure: G10 Momentum Portfolio
USD Cash Returns USD Momentum
Asset: Cash USD 1M

USD Total Returns and USD Momentum
1.4
10
USDEUR_CURNCY (left axis)
US0001M_CURNCY (right axis)
8
USD Momentum (left axis)
1.2
as.zoo(x)
USD Returns (right axis)
6
1.0
0.8
4
0.8
2
0.6
2
1980 1985 1990 1995 2000 2005 2010
0.6
Index
TradingStrategy: CASH USD
1.0
market position Long
1
market position Short
0.4
0.5
as.zoo(x)
0.0
0
−0.5
0.2
−1.0
−1
1980 1985 1990 1995 2000 2005 2010
0.0
StrategyReturns: CASH USD
fx
−2
1.0
yield
transactions
−0.2
slippage
0.5
as.zoo(x)
total
0.0
−3
−0.5
1980 1985 1990 1995 2000 2005 2010

1980 1985 1990 1995 2000 2005 2010
G10 Momentum Ranked G10 Momentum
G10 Momentum Ranked G10 Momentum
10
10
CASH EUR
8
CASH EUR
CASH CAD
CASH USD
6
CASH JPY
4
4
CASH GBP
2
CASH CHF
100
100
CASH CAD
CASH AUD
8
CASH AUD
CASH USD
CASH NZD
6
2
CASH NOK
4
CASH SEK
2
100
100
8
8
CASH NZD
as.zoo(x)
CASH JPY
6
0
4
2
2
100
100
8
8
CASH NOK
CASH GBP
−2
6
4
4
2
2
100
100
8
8
CASH CHF
CASH SEK
−4
6
4
4
2
2
0
0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

G10 Momentum G10 Momentum Portfolio Positions
G10 Momentum Portfolio Positions:G10 Momentum Ranker
0.0 0.5 1.0
0.0 0.5 1.0

CASH EUR
CASH EUR
CASH CAD
CASH USD
CASH JPY
4
CASH GBP
CASH CHF
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

CASH CAD
CASH AUD
CASH AUD
CASH USD
CASH NZD
2
CASH NOK
CASH SEK
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

CASH NZD
as.zoo(x)
CASH JPY
0
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

CASH NOK
CASH GBP
−2
−1.0
−1.0
0.0 0.5 1.0
0.0 0.5 1.0

CASH CHF
CASH SEK
−4
−1.0
−1.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Returns to the Long-Only G10 Momentum Portfolio
G10 Momentum Portfolio Performance G10 Momentum Portfolio Components
RoI Index of: G10 Momentum Portfolio Components Positions: G10 Momentum Portfolio
1.0
CASH USD
140
0.5
CASH JPY
CASH GBP
CASH CHF
0.0
CASH CAD
120
CASH AUD
−0.5
CASH NZD
CASH NOK
100
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
TradingStrategy: G10 Momentum Portfolio Portfolio Components StrategyReturns: G10 Momentum Portfolio
1.0
0.2
0.5
CASH JPY
0.1
CASH GBP
as.zoo(x)
CASH CHF
0.0
0.0
CASH CAD
CASH AUD
CASH NZD
−0.5
CASH NOK
−0.2
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
StrategyReturns: G10 Momentum Portfolio Performance Attribution: G10 Momentum Portfolio @ 2009−05−15
0.2
fx CASH EUR
yield CASH USD
0.1
0.4

slippage CASH GBP
as.zoo(x)
0.0
total CASH CHF
0.2
CASH CAD
CASH AUD
−0.2 −0.1
CASH NZD
0.0
CASH NOK
CASH SEK
−0.2
1980 1985 1990 1995 2000 2005 2010

Carry and Momentum Returns
FX Carry and Momentum Indices FX Carry and Momentum Correlation

FX Carry Index Perfromance
vs. FX Momentum Index Perfromance Scatterplot: FX Carry Total Returns vs. FX Momentum Total Returns
Correlation: 0.03
250
FX Carry Index
FX Momentum Index
0.10
●
200
●
150
100
●
●
0.05
1980 1985 1990 1995 2000 2005 2010
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FX Carry Total Returns ●
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0.05
●
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Carry Returns ●
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Carry Returns
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1980 1985 1990 1995 2000 2005 2010 ● ●
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FX Momentum Total Returns ● ●
0.10
●
Momentum Returns
●
0.05
0.00
●
−0.05
−0.10 −0.05 0.00 0.05

1980 1985 1990 1995 2000 2005 2010
Momentum Returns
Risk Indicator: Equity Volatility Component
Equity Risk Timeseries Normalized Equity Volatility Timeseries
Risk Factors: Equity Volatility Normalized Risk Factors: Equity Volatility

70
z−score: VIX_INDEX
4
VIX_INDEX
50
2
30
0
−2
10
60
z−score: VDAX_INDEX
4
50
VDAX_INDEX
40
2
30
0
20
−2
10
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Risk Indicator: Equity Volatility Component
Equity Volatility Timeseries Equity Volatility Risk Indicator Component
Normalized Risk Factors: Equity Volatility

Risk Factors: Equity Volatility
z−score: VIX_INDEX
z−score: VDAX_INDEX
Risk Indicator: Equity Vola Component
70
VIX_INDEX
4
50
30
as.zoo(x)
10
2
60
50
VDAX_INDEX
40
0
30
20
10
−2
1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Risk Indicator: Equity Positioning Component
Equity Positioning Timeseries Normalized Equity Positioning Timeseries
Risk Factors: Equity Market Positioning Normalized Risk Factors: Equity Market Positioning
Index MSCI Growth/Value Index
4
0.0
MSCI Growth/Value Index
3
2
−0.2
1
0
−0.4
−1
z−score: MSCI Defensives/Cyclicalsz−score:
−3
1.5−0.6
MSCI Defensives/Cyclicals Index
4
2
1.0
0
0.5
−2
0.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Risk Indicator: Equity Positioning Component
Equity Positioning Timeseries Equity Positioning Risk Indicator Component
Normalized Risk Factors: Equity Market Positioning

Risk Factors: Equity Market Positioning
z−score: MSCI Growth/Value Index
z−score: MSCI Defensives/Cyclicals Index
0.0
4
Risk Indicator: Equity Posi Component
MSCI Growth/Value Index
−0.2
2
−0.4
as.zoo(x)
1.5−0.6
MSCI Defensives/Cyclicals Index
0
1.0
0.5
−2
0.0
1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Risk Indicator: FX Volatility Component
FX Volatility Timeseries Normalized FX Volatility Timeseries
Risk Factors: FX Volatility Normalized Risk Factors: FX Volatility
z−score: JPMVXYG7_INDEX
4
20
JPMVXYG7_INDEX
2
15
0
10
−2
z−score: JPMVXYEM_INDEX
6
30
JPMVXYEM_INDEX
25
4
20
2
15
0
10
−2
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Risk Indicator: FX Volatility Component
FX Volatility Timeseries FX Volatility Risk Indicator Component
Normalized Risk Factors: FX Volatility

Risk Factors: FX Volatility
z−score: JPMVXYG7_INDEX
z−score: JPMVXYEM_INDEX
6
Risk Indicator: FX Vola Component
20
JPMVXYG7_INDEX
15
4
10
as.zoo(x)
2
30
JPMVXYEM_INDEX
25
0
20
15
−2
10
1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Risk Indicator: Yield and Credit Component
Yield and Credit Timeseries Normalized Yield and Credit Timeseries
Risk Factors: Yield and Credit Conditions Normalized Risk Factors: Yield and Credit Conditions
z−score: USSP2_CMPL_CURNCY
140
USSP10_CMPL_CURNCY USSP2_CMPL_CURNCY
4
100
2
0
60
−2
20
4
100
2
0
60
−2
20
−4
z−score: usa credit spread z−score: .TEDSP_INDEX
4
4
.TEDSP_INDEX
2
2
0
1
−2
60
4
5
usa credit spread
2
4
3
0
2
−2
1
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Yield and Credit Timeseries Yield and Credit Risk Indicator Component
Risk Factors: Yield and Credit Conditions Normalized Risk Factors: Yield and Credit Conditions
140
USSP10_CMPL_CURNCY USSP2_CMPL_CURNCY
100
z−score: .TEDSP_INDEX
z−score: usa credit spread
60
4
20
100
2
60
as.zoo(x)
20
4
.TEDSP_INDEX
0
2
1
60
5
−2
usa credit spread
4
3
2
1
−4
1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Risk Indicator: Safe Haven Component
Safe Haven Timeseries Normalized Safe Haven Timeseries
Risk Factors: Safe Haven Assets Normalized Risk Factors: Safe Haven Assets
1000
4
z−score: GOLDS_INDEX
800
GOLDS_INDEX
2
600
0
400
−2
1.0
z−score: CHFUSD_CURNCY
3
CHFUSD_CURNCY
2
0.8
1
0
0.6
−3 −2 −1
0.4
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Safe Haven Timeseries Safe Haven Risk Indicator Component
Normalized Risk Factors: Safe Haven Assets

Risk Factors: Safe Haven Assets
z−score: GOLDS_INDEX
1000
4
z−score: CHFUSD_CURNCY
800
GOLDS_INDEX
600
2
400
as.zoo(x)
1.0
0
CHFUSD_CURNCY
0.8
0.6
−2
0.4
1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010

Aggregated Risk Indicator
Risk Indicator Timeseries
Risk Indicator & Subcomponents

We calculate the aggregated Risk
6

Risk Indicator: Equity Posi Component
Risk Indicator: FX Vola Component
Indicator by equally weighting
Risk Indicator: Safe Haven Component the 5 sub-components:
4
risk indicator value
Equity Volatility
2
as.zoo(x)
Equity Positioning
FX Volatility
0
Yield and Credit

−2
Safe Haven
1980 1985 1990 1995 2000 2005 2010
The Aggregated Risk Indicator
risk indicator value

3
We will use the aggregated Risk

2
Indicator as a measure for

1
risk-appetite (low indicator

0
values) and risk-aversion (high

indicator values) in the markets.
−1
−2
−3
1980 1985 1990 1995 2000 2005 2010

Outline
1 Introduction
2 Methodology
3 Data

Moving-Average Crossover Rule
Moving Average Crossover/Risk-Indicator Combination
5 Conclusion
6 References
Timing the Carry Trade with a Moving Average Crossover
Rule
Moving Average Crossover Signal

We create a simple Carry timing
TradRule1: Moving Average Crossover (1,52)
indicator, following standard
250
FX Carry Index
tsRollMean(FX Carry Index,1)
tsRollMean(FX Carry Index,52)
moving average crossover trading

200
as.zoo(x)
150
rules:
100
1980 1985 1990 1995 2000 2005 2010
Index
Trading Signal
Entry Long when the FX
1.0
SignalPositions_EntriesExits Long
Carry Index crosses over the

SignalPositions_EntriesExits Short
0.5
0.0
52-period moving average.

−0.5
−1.0
1980 1985 1990 1995 2000 2005 2010
Market Entry/Exit Signals

Entry Short when the FX
1.0
entry long
exit long
Carry Index crosses under
0.8
entry short
exit short
as.zoo(x)
0.6
the 52-period moving

0.4
0.2
average.
0.0
1980 1985 1990 1995 2000 2005 2010

Timing the FX Carry Trade with a Moving Average
Crossover Rule
Timed FX Carry Portfolio Timed FX Carry Portfolio Components
1.0
250

CASH USD
0.5
CASH JPY
CASH GBP
200
CASH CHF
0.0
CASH CAD
CASH AUD
150
−0.5
CASH NZD
CASH NOK
CASH SEK
−1.0
100
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
1.0
0.4
0.5
CASH JPY
0.2
CASH GBP
as.zoo(x)
CASH CHF
0.0
CASH CAD
0.0
CASH AUD
CASH NZD
−0.5
−0.2
CASH NOK
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
fx CASH EUR
yield 0.3 CASH USD
0.8

slippage CASH GBP
0.2
as.zoo(x)
total CASH CHF

CASH CAD
0.4
0.1
CASH AUD
CASH NZD
CASH NOK
0.0
0.0
CASH SEK
1980 1985 1990 1995 2000 2005 2010

Timing the FX Momentum Trade with a Moving Average
Crossover Rule
Moving Average Crossover Signal We create a simple Momentum

TradRule1: Moving Average Crossover (1,52)
timing indicator, following
FX Momentum Index
tsRollMean(FX Momentum Index,1)
standard moving average
140
tsRollMean(FX Momentum Index,52)

as.zoo(x)
crossover trading rules:

120
100
1980 1985 1990 1995
Index
Trading Signal
2000 2005 2010
Entry Long when the FX
Momentum Index crosses
1.0
0.5
over the 52-period moving

0.0
−0.5
average.
−1.0
1980 1985 1990 1995 2000 2005 2010

Entry Short when the FX
1.0
entry long
exit long
0.8
entry short
exit short
Momentum Index crosses
as.zoo(x)
0.6
0.4
under the 52-period moving

0.2
0.0
1980 1985 1990 1995 2000 2005 2010
average.
Timing the FX Momentum Trade with a Moving Average
Crossover Rule
Timed FX Momentum Portfolio Timed FX Momentum Portfolio Components
1.0
CASH USD
140
0.5
CASH JPY
CASH GBP
CASH CHF
0.0
CASH CAD
120
CASH AUD
−0.5
CASH NZD
CASH NOK
100
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
0.2
1.0

0.5
0.0
CASH JPY
CASH GBP
as.zoo(x)
CASH CHF
0.0
−0.2
CASH CAD
CASH AUD
CASH NZD
−0.5
−0.4
CASH NOK
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
0.1
fx CASH EUR
yield CASH USD
0.0

−0.1
slippage CASH GBP

as.zoo(x)
−0.2
total CASH CHF

CASH CAD
−0.3
CASH AUD
−0.4
CASH NZD
CASH NOK
−0.5
CASH SEK
−0.6
1980 1985 1990 1995 2000 2005 2010

Timing the FX Carry Trade with a Risk Indicator Filter
Rule
Risk Indicator Signal
TradRule1: Risk Indicator Filter

We create a Risk-Indicator based
3
Risk−Appetite Indicator
threshold line: 0
2
Carry timing indicator, following

1
as.zoo(x)
0
−1
the following trading rules:

−2
−3
1980 1985 1990 1995 2000 2005 2010
Index
Trading Signal
Entry Long when the
1.0
0.5
Risk-Appetite Indicator
0.0
crosses over the zero-line.

−0.5
−1.0
1980 1985 1990 1995 2000 2005 2010
Market Entry/Exit Signals Entry Short when the

1.0
entry long
exit long
0.8
entry short
exit short
as.zoo(x)
0.6
0.4
crosses under the zero-line.

0.2
0.0
1980 1985 1990 1995 2000 2005 2010

Timing the FX Carry Trade with a Risk Indicator Filter
Rule
1.0
250

CASH USD
0.5
CASH JPY
CASH GBP
200
CASH CHF
0.0
CASH CAD
CASH AUD
150
−0.5
CASH NZD
CASH NOK
CASH SEK
−1.0
100
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
1.0
0.2
0.5
CASH JPY
CASH GBP
as.zoo(x)
0.0
CASH CHF
0.0
CASH CAD
CASH AUD
−0.2
CASH NZD
−0.5
CASH NOK
CASH SEK
−1.0
−0.4
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
0.2
0.4
fx CASH EUR
yield 0.1 CASH USD
0.2
slippage CASH GBP

as.zoo(x)
total CASH CHF

0.0
0.0
CASH CAD
CASH AUD
−0.1
−0.4 −0.2
CASH NZD
CASH NOK
CASH SEK
−0.2
1980 1985 1990 1995 2000 2005 2010

Timing the FX Momentum Trade with a Risk Indicator
Filter Rule
Risk Indicator Signal
TradRule1: Risk Indicator Filter

We create a Risk-Indicator based
3
Risk−Appetite Indicator
threshold line: 0
Momentum timing indicator,
2
1
as.zoo(x)
following the following trading

0
−1
−2
rules:
−3
1980 1985 1990 1995 2000 2005 2010
Index
Trading Signal
1.0
Entry Long when the
0.5
0.0
−0.5
crosses over the zero-line.

−1.0
1980 1985 1990 1995 2000 2005 2010
Entry Short when the

1.0
entry long
exit long
0.8
entry short
exit short
as.zoo(x)
0.6
0.4
0.2
crosses under the zero-line.

0.0
1980 1985 1990 1995 2000 2005 2010

Timing the FX Momentum Trade with a Risk Indicator
Filter Rule
1.0
CASH USD
140
0.5
CASH JPY
CASH GBP
CASH CHF
0.0
CASH CAD
120
CASH AUD
−0.5
CASH NZD
CASH NOK
100
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
1.0
0.1 0.2
0.5
CASH JPY
CASH GBP
as.zoo(x)
CASH CHF
0.0
CASH CAD
−0.1
CASH AUD
CASH NZD
−0.5
CASH NOK
CASH SEK
−0.3
−1.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
0.2
0.0 0.2 0.4 0.6
fx CASH EUR
yield 0.1 CASH USD
slippage CASH GBP
as.zoo(x)
0.0
total CASH CHF

CASH CAD
CASH AUD
CASH NZD
CASH NOK
−0.2
CASH SEK
−0.4
1980 1985 1990 1995 2000 2005 2010

Timing the FX Carry Trade with a combined Moving
Average/Risk Appetite Signal
Combined Moving Average/Risk Appetite Signal
Position Signal: Aggregated Strategy Signal

1.4
position
1.0
Trading Rules:
0.6
1980 1985 1990 1995 2000 2005 2010
Position Signal: Moving Average Crossover (1,52)
Long When the Moving

1.0
position
−1.0 0.0
1980 1985 1990 1995 2000 2005 2010

Average Rule AND the
Filter Signal: Risk Indicator Filter
Risk-Indicator rule are long.

1.0
filter
−1.0 0.0
1980 1985 1990 1995
Aggregated Strategy Signal

2000 2005 2010
Short When the Moving
1.0
market position
−1.0 0.0
1980 1985 1990 1995
Strategy Trades
2000 2005 2010
Risk-Indicator rule are short.
2
buy
sell
0
−2
1980 1985 1990 1995 2000 2005 2010

Timing the FX Carry Trade with a combined Moving
1.0
250

CASH USD
0.5
CASH JPY
CASH GBP
200
CASH CHF
0.0
CASH CAD
CASH AUD
150
−0.5
CASH NZD
CASH NOK
CASH SEK
−1.0
100
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
1.0
0.2
0.1
0.5
CASH JPY
CASH GBP
as.zoo(x)
−0.1 0.0
CASH CHF
0.0
CASH CAD
CASH AUD
CASH NZD
−0.5
CASH NOK
CASH SEK
−1.0
−0.3
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
0.6
fx CASH EUR
yield 0.15 CASH USD
0.4
slippage CASH GBP

as.zoo(x)
total CASH CHF

0.05
CASH CAD
0.2
CASH AUD
CASH NZD
0.0
CASH NOK
CASH SEK
−0.05
1980 1985 1990 1995 2000 2005 2010

Timing the FX Momentum Trade with a combined Moving
Combined Moving Average/Risk Appetite Signal
Position Signal: Aggregated Strategy Signal

1.4
position
1.0
Trading Rules:
0.6
1980 1985 1990 1995 2000 2005 2010
Position Signal: Moving Average Crossover (1,52)
Long When the Moving

1.0
position
−1.0 0.0
1980 1985 1990 1995 2000 2005 2010

Filter Signal: Risk Indicator Filter
Risk-Indicator rule are long.

1.0
filter
−1.0 0.0
1980 1985 1990 1995
Aggregated Strategy Signal

2000 2005 2010
Short When the Moving
1.0
market position
−1.0 0.0
1980 1985 1990 1995
Strategy Trades
2000 2005 2010
Risk-Indicator rule are short.
2
buy
sell
0
−2
1980 1985 1990 1995 2000 2005 2010

Timing the FX Momentum Trade with a combined Moving
1.0
CASH USD
140
0.5
CASH JPY
CASH GBP
CASH CHF
0.0
CASH CAD
120
CASH AUD
−0.5
CASH NZD
CASH NOK
100
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980−01−04 1983−09−09 1987−05−15 1991−01−18 1994−09−23 1998−05−29 2002−02−01 2005−10−07
1.0
0.1
0.5
CASH JPY
CASH GBP
as.zoo(x)
CASH CHF
−0.1
0.0
CASH CAD
CASH AUD
CASH NZD
−0.5
CASH NOK
−0.3
CASH SEK
−1.0
1980 1985 1990 1995 2000 2005 2010 1980 1985 1990 1995 2000 2005 2010
Index
0.3
fx CASH EUR
yield 0.1 CASH USD
0.0
slippage CASH GBP

0.1
as.zoo(x)
total CASH CHF

CASH CAD
−0.2
CASH AUD
−0.1
CASH NZD
CASH NOK
CASH SEK
−0.3
−0.4
1980 1985 1990 1995 2000 2005 2010

Outline
1 Introduction
2 Methodology
3 Data
5 Conclusion
6 References
Dynamic FX Portfolio Trading: Status-Quo
We built a software for backtesting portfolios of trading

systems.
We tested benchmark FX Carry and Momentum portfolio
timing strategies with mixed results.
The approach of combining different types of market timing
rules looks promising.
Next steps: Calculation of the statistical market timing
indicators based on risk-factors.
Outline
1 Introduction
2 Methodology
3 Data
5 Conclusion
6 References
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Can risk aversion indicators anticipate financial crises?
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Trading foreign exchange portfolios with volatility filters: the
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Trading the forward bias: Are there limits to speculation?
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Dynamic FX Portfolios

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Dynamic FX Portfolios

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Dynamic Trading of FX Carry and Momentum

Cass Business School, City University, London

4 Benchmark Market Timing Rules

4 Benchmark Market Timing Rules

Definition: Carry Trading

Definition: Momentum Trading

Carry and Momentum trading styles in FX markets are

Timing FX Carry/Momentum with RiskMetrics Volatility Estimates

Relationship of FX Carry portfolios with risk-factors and monetary variables

Risk-Factors as Inputs for Market Timing Indicators

Do risk-factors allow to forecast periods of profitable FX Carry

Do more advanced statistical models outperform simple market

Do nonlinear neural network based modeling techniques add value

4 Benchmark Market Timing Rules

Simple Moving-Average Crossover Rule

Several studies have reported enhanced predictability of signs of

4 Benchmark Market Timing Rules

G10 FX and Yield Data

G10 FX Carry and Momentum Indices

Risk-Factors & Risk Indicator

Financial risk-factors will serve as inputs to the FX portfolio timing models.

G10 1-Week Yield Data

G10 1-Month Yield Data

SF0001M_CURNCY BP0001M_CURNCY JY0001M_CURNCY US0001M_CURNCY EUR001M_CURNCY

G10 Foreign Exchange Rate Data

SEKEUR_CURNCY NOKEUR_CURNCY NZDEUR_CURNCY AUDEUR_CURNCY

0.4 0.5 0.6 0.7

CADEUR_CURNCY CHFEUR_CURNCY GBPEUR_CURNCY

1980 1985 1990 1995 2000 2005 2010

We build weekly carry and momentum return indices by

1 Rank the G10 currencies according to their yield (Carry) or

G10 Yields Ranked G10 Yields

G10 Yields Ranked G10 Yields

1980 1985 1990 1995 2000 2005 2010

G10 Yields G10 Carry Portfolio Positions

G10 Yields Portfolio Positions:G10 Carry Ranker

0.0 0.5 1.0

0.0 0.5 1.0

0.0 0.5 1.0

0.0 0.5 1.0

0.0 0.5 1.0

0.0 0.5 1.0

1980 1985 1990 1995 2000 2005 2010

G10 Carry Portfolio Performance G10 Carry Portfolio Components

Strategy RoI Index CASH EUR

market position Long CASH EUR

slippage CASH GBP

total CASH CHF

1980 1985 1990 1995 2000 2005 2010

USD Cash Returns USD Momentum

Asset: Cash USD 1M

USD Returns (right axis)

market position Long

1980 1985 1990 1995 2000 2005 2010

G10 Momentum Ranked G10 Momentum

G10 Momentum Ranked G10 Momentum

1980 1985 1990 1995 2000 2005 2010

G10 Momentum G10 Momentum Portfolio Positions

G10 Momentum Portfolio Positions:G10 Momentum Ranker

0.0 0.5 1.0

0.0 0.5 1.0

0.0 0.5 1.0

0.0 0.5 1.0