How poor liquidity creates rational price distortions

June 4, 2016

When OTC markets become illiquid and dealers fail to buffer flows, institutional investors effectively face each other directly in the market. They can observe each other’s actions and position changes. For example, if large investors make offers to sell under illiquidity, the market expects to become “over-positioned” and will avoid bids at a fair price or even put in offers. In equilibrium investors transact at prices below true value and exacerbate initial negative shocks.

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Understanding market beta in FX

May 25, 2016

The beta of an investment measures its sensitivity to “market returns”. Unlike in equity, in FX the relevant benchmark for a beta cannot be a long-only index. Instead, an FX-specific beta can be based on common types of currency strategies, such as carry and trend. Currency betas measured against such benchmarks can be valuable for portfolio construction and measuring positioning risk.

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Understanding bid-offer spreads in OTC markets

May 14, 2016

Bid-offer spreads are traditionally explained by inventory costs, operating expenses and dealers’ risk of transacting with better-informed clients. In OTC (over-the-counter) markets, however, client knowledge and market power of dealers gives rise to price discrimination in favor of clients with high volumes and sophistication. Institutional investment strategies in forwards, swaps and options that are sensitive to transaction cost must consider the institution’s standing with their market makers.

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The term premium of interest rate swaps

May 7, 2016

A Commerzbank paper proposes a practical way to estimate term premia across interest rate swap markets. The method adjusts conventional yield curves for median error curves, i.e. for recent tendencies of implied future yields to overpredict spot yields. The adjustment produces “neutral curves” or presumed unbiased predictors of future yields. The neutral curves can then be used to back out term premia.

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Using commodity prices to predict exchange rates

April 9, 2016

A new empirical study confirms that export price changes explain a substantial part of commodity currency fluctuations, particularly at high frequencies. More importantly, country-specific export price indices help predicting commodity countries’ future exchange rate dynamics. The predictive power appears to be most robust over a horizon of one month.

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Pension funds and herding

April 2, 2016

Pension funds have three types of motivations for herding: rebalancing rules, the effects of regulatory changes and peer pressure of senior executives. A new empirical study detects all of these in the trading flows of the large Dutch pension funds. These flows offer opportunities for contrarian traders that provide liquidity to the “herd”.

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Inefficient benchmarking and trading opportunities

March 25, 2016

Academic research explains how benchmarking induces investment managers to buy overvalued highly volatile assets. This makes markets inefficient and may even lead to a negative relation between risk and return. It also offers opportunities for investment strategies. First, value investors can exploit the market’s proclivity to overvalue high-beta and high-volatility assets. Second, momentum traders can exploit the flows of funds in the benchmarked industry.

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How to measure economic uncertainty

March 19, 2016

Measures of economic uncertainty help investors to track popular fear or complacency for the purpose of trading strategies. Academic papers propose various methods: keyword frequencies in news, equity market volatility, earnings forecast dispersion and economic forecast disagreements. Composite measures suggest that uncertainty typically rises abruptly but declines just gradually.

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Rational informational herding

February 27, 2016

It can be rational for traders to buy with rising prices and sell with falling prices. In particular, this should be the case if traders possess private information suggesting that “something big” is coming and that prices may move significantly, even if direction is not certain (e.g. “make-or-break” situations). Experiments confirm such rational informational herding.

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EM exchange rates and self-reinforcing trends

February 6, 2016

Emerging market exchange rates can be catalysts of self-reinforcing trends. Currency appreciation raises both global lenders’ risk limits and EM institutions’ debt servicing capacity. Currency depreciation spurs the reverse dynamics. Their escalatory potential constrains central banks’ tolerance for exchange rate flexibility.

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asset management Asset Purchase Program banks bond returns bond yields bubbles capital regulation carry China collateral commodities credit returns default ECB economic data EM equity returns euro area crisis Fed financial crisis FX FX interventions FX returns government debt government deficits herding inflation information insurances Japan leverage liquidity machine learning market turmoil price factors regulation risk management shadow banking statistical methods term structure trend following variance risk premium VIX volatility ZLB
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Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.

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