Abstract
My thesis consists of three essays investigating sources of profits to price momentum and related trading strategies in financial markets. Although each essay can stand independently, the methods used in them overlap and their concepts are closely interrelated.
My first essay (Chapter 2) examines price momentum in emerging currency markets. I find that long-short momentum strategies gain about 1–3% per annum after actual transaction costs. These results are similar to, but more volatile than, those already published for major currencies. My findings contrast starkly with those of the only other comprehensive paper published in the very limited literature in this area. Contrary to published results in major currencies, I find that emerging market currency momentum strategies typically borrow in high interest rate currencies and invest in low interest rate currencies. Also, as the domestic interest rates of the base currency rise in the cross section, momentum profits fall and the return attribution shifts from the short position to the long position.
My second essay (Chapter 3) examines price and earnings momentum in the New Zealand stock market, with careful attention paid to the crisis period and to transaction costs. A feature of this study is the first application of a realistic practitioner trading technique to combined momentum strategies. I am the first to look at the interrelationship between fund size, turnover, trading frequency, and exposure to ex-ante alphas in this context. My results confirm the existence of both price and earnings momentum in the New Zealand equity market. The best strategy I find outperforms the benchmark by 100 basis points per annum after a careful consideration of transaction costs.
Although the 2007–2009 crisis significantly increased transaction costs in general, the earnings momentum strategy and the combined momentum strategies perform better net of transaction costs during this period than during the non-crisis periods. This unexpected result is explained by lower turnover of the momentum strategies during the crisis period leading, in turn, to lower transaction costs and also (I hypothesize) better performance of the earnings momentum strategy during periods of increased information uncertainty.
My third essay (Chapter 4) brings together the ideas in the first two essays and introduces a new post-macroeconomic-announcement drift (POMAD) trading strategy in currencies—analogous to the well-known post-earnings-announcement drift in equities. Although the POMAD strategies are profitable on average over the entire sample, and price momentum strategies are generally unprofitable on average, I show that price momentum profits are related to POMAD profits in the major currency markets.
I find that profits to both POMAD and price momentum strategies are time varying, that the full impact of news is incorporated only slowly into currency prices, and that price momentum and my POMAD trading strategies are all profitable in major currencies during the recent crisis period. Among my macroeconomic variables, the consumer price index is the least influential variable, while industrial production, trade balances, and the unemployment rate are the most influential.