LB's Global FX Strategies, April 19, 2007

LB's Global FX Strategies
April 19, 2007

I. Trading FX on an episodic risk basis, p.23

1. FX carry trades could be considered a strategy with steady positive return but with infrequent large drawdowns.

2. LB's risk filter

• Market Risk Sentiment Index, MARS
• RPI
• VIX index
• Credit Market Spread (= Moody's AAA rated corporate bond yields less 30-year Treasury yield)
• FX implied volatility (Global Hazard Index, GHI) see definition on p.25.

3. Comparing the difference among passive and activity carry trade strategies

Passive carry trade strategies (Long or Exit the carry)

• Strategy 1 (continuous-based strategy) : Equally weighted basket of Long high-yield currencies (AUD/ NZD/ SEK/ CAD) Short low-yield currencies (CHF/ JPY)
  
• Strategy 2 (discrete-based strategy) : Using MARS Index be a downside risk filter. Long carry if MARS is in the risk averse area. Exit carry if MARS is in the risk loving area.

Activity carry trade strategies : (Long or Short the carry)

• Using the value of risk filter index to make a Z-score. The Z-score of risk factors could measure risk extremes, and points out the long / short direction.
• Z-score = risk factor's 6-month rolling average / 6-month rolling standard deviation
• In the other words, the Z-score measure how far away (in number of standard deviations) the risk conditions are from the normal levels.
• A large negative Z-score signals benign risk conditions => Long carry
• A large positive Z-score signals severe risk conditions => Short carry
• Strategy 1 : Using the RPI be the risk factor
• Strategy 2 : Using the VIX index be the risk factor
• Strategy 3 : Using the Credit Market Spread be the risk factor
• Strategy 4 : Using the GHI be the risk factor
• Other decision variable, Threshold ( -1, -1.5, -2 )

The results among the strategies:

• Data from 1996-2007
• Annualised average return
• the benchmark (passive carry trade strategies (Long or Exit the carry)) is 5.04%
• Passive : discrete-based strategy is 6.21%
• Activity (Threshold sets at -2) : VIX is 11.78%, Credit Spread is 20.21%, FX Vol is 3.48%
• From max drawdown aspect, Credit Spread is 2.0% far less than Benchmark's 17.9%.
  

II. China Focus, p.22

• In the early 1990s, China hade a dual-exchange rate regime: the PBoC's official rate for all transactions through the banking system, while exporters could trade part of their retained FX earnings among themselves at market-determined rate. As of December 1993, the market rate was 8.80 CNY/USD, and official rate was 5.80.
• 1994 1/1, 正式成立外匯市場, 將官方匯率定在8.70. 稱之為"a managed-floating regime based on market supply and demand" 且匯率是由在China Foreign Exchange Trading Centre (CFETC)內的交易所決定.
• RMB gradually appreciated to 8.27 until Asian financial crisis. While most Asian currencies depreciated in 1998, RMB almost unchanged at 8.27 and stayed at this level for the next 8 years.
• 2005/07/21, "CNY revaluation on 21 July 2005.
• 2005年7月21日起，央行宣佈開始實行以市場供求 (managed-floating regime based on market supply and demand) 為基礎、參考一籃子貨幣(Top trade partners - US, Japan, Euro, South Korea, Singapore, UK, Malaysia, Russia, Australia, Thailand, Canada)進行調節、有管理的浮動匯率制度。(人民幣兌美元的匯率8.11)
• After CNY revaluation on 21 July 2005, today, spot trading of RMB through the CFETC (5%) via 22 commercial banks' OTC market (95%). Every morning, the PBC announces central parity rates based on the weighted average of quotes from the market makers. The RMB is allow to trade in a range of 0.3% on either side of the central parity rate against the USD and 3% against other currencies.