Archive for December, 2008

Strategy to reduce short-term volatility to prevent large scale price shocks in foreign exchange

The credit and equity markets have been rocked by exceptional events. The currency markets have seemingly been spared of a lot of grief, even though there have been large scale price moves of 20 and 30 percent, but not as detrimental as the events in the other markets. We argue that it is only a matter of time until similarly catastrophic events occur in the currency markets. We argue that central banks have to take a pro-active role in the foreign exchange markets to dampen volatility and prevent big price shocks in the currency market. We are not arguing for large scale interventions, but for an ongoing quantitative intervention strategy to provide market liquidity in the spot currency markets, whenever there is a short-term imbalance of demand and supply. Imbalances of demand and supply have an amplified impact: price spikes trigger margin calls, which lead to a cascade of margin calls setting in train massive price dislocations…

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December 16th, 2008 | Economics, News | | No Comments »

Call for a global early warning system

With the deepening economic crisis there have been repeated calls for an early warning system of the world economy. Little has been said, how such a system should be built.

To build a global early warning system we have to overcome the predicament that Alan Greenspan highlighted: ‘How do we know when international exuberance has unduly escalated asset values?….We should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy…

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December 16th, 2008 | General, News | | No Comments »

Investing in Currency

Investing in a portfolio of currencies is different from currency trading. The success of currency trading comes, obviously, from being on the right side—either long or short—of one transaction. In a certain sense this is like successful stock-picking: you commit to one position; you hope that the equity you choose will, sooner or later, be valued at a higher rate when you decide to sell it; you expect that if you time your sale correctly other investors will be willing to buy the security, even at its appreciated price.

Currency investing is different. Compared to investing in stocks or bonds, its time horizons are greatly compressed (meaning that the effects of trading volume plus liquidity plus the perceived value of a currency can present greater opportunities for gain and loss in one day that you might expect on conventional equity and fixed income markets in one year).

The equality of gains and losses: conventional investing is based on the notion of one-sided ownership: you buy (go long)…you hold…you sell. Currency markets, in contrast, place equal value on selling (going short); this is reflected in the very nature of every currency transaction because you must buy and sell a pair: you cannot take a one-sided position. As a practical matter, this means that opportunities exist regardless of whether “the market” is rising, falling, or moving sideways…

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December 16th, 2008 | Investment, News | | No Comments »

A New Framework for Risk and Return In Liquid Markets

Action, reaction, and the echoes of uncertainty:
the R&D we should be doing, and how that will contribute
to true efficiency in the marketplace

Richard Olsen challenges three received notions that mire the global economy in counter-productive habits that destroy value: that market prices in gross time tell us everything we need to know; that such information as we have is a trustworthy indicator of things to come; and that the chain of events in price evolution is orderly and self-correcting.

Olsen Ltd. has discovered and validated 17 new power laws that prove this firm’s long-held belief: much of the market’s volatility is invisible to casual, low-resolution analysis. While much work remains to be done, Olsen is taking steps to encourage the accumulation and analysis of very-high-resolution data to fuel sophisticated models that leverage the insights and power of the new scaling laws. With two strategic objectives: to increase return as a product of the predictive capacity of better trading models, and to counter the effect of inevitably irrational behavior by providing liquidity in the face of skewed pricing patterns…

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December 16th, 2008 | High frequency finance, News | | No Comments »

Trading the currency markets: Is gut feeling still state-of-the-art?

The first shall be last, and the last first.
In the 1990s every large bank that wanted to be taken seriously placed a huge bet on their trading engines. But it was a long shot: they hired rocket scientists with the mandate to develop trading models based on neural networks, genetics algorithms and other magical tools that had paid off in the more respected disciplines of hard science…

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December 16th, 2008 | Investment, News | | 1 Comment »

The fallacy of the Invisible Hand

Since the inception of classical economics over 200 years ago, one of the most sacred assumptions has been the hypothesis that an invisible hand determines market prices and that market prices follow a random walk. Today, there exists significant statistical evidence that this is not the case and we need to acknowledge that financial markets are, indeed, predictable. How is this possible?…

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December 15th, 2008 | Economics, News | | No Comments »