Presentation of the paper:

Mispricing and Predictability in Currency Markets

 
Speaker: Valerio Potì
 
Abstract:

We consider two alternative stylized currency pricing models. In the first model, the marginal currency trader can diversify away currency risk but in the second one this possibility is precluded. Under the RE null, we find strong evidence against the former but relatively weak evidence against the latter. With the exception of the 1970s, episodes of mispricing are short-lived and, as predicted by “limits to speculation models”, their magnitude is inversely related to proxies for the availability of risk capital. Our results pose a challenge to Fama’s (1970) Efficient Market Hypothesis, but are consistent with microstructure models of foreign exchange markets à la Lyons (2001) in which undiversified marginal currency traders seek reward for total risk instead of systematic risk only as well as with Lo’s (2004) Adaptive Market Hypothesis.