Essays on currency markets
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The first chapter investigates the dynamic behavior of exchange rates around FOMC announcements. The excess returns of holding a foreign currency are higher from 36 hours before to 12 hours after the announcements (14:15 EST). 75% of the positive drifts are cancelled out by the negative drifts from 12 hours to 24 hours after the announcements. Empirical analyses using intraday data indicate that extreme positive returns (i.e., lottery returns) drive the higher excess returns and radical reversion after FOMC announcements. These findings are consistent with the cases where U.S dollar holders require compensations for risks of sudden and large depreciation of the U.S. dollars. The second chapter investigates the predictability of jumps in currency markets and shows the implications for carry trades. Formulating new currency jump analyses, this chapter proposes a general method to estimate the determinants of jump sizes and intensities at various frequencies. This chapter reveals significant predictive relationships between currency jumps and national fundamentals. The patterns of intraday jumps are identified; multiple currency jump clustering and time-of-day effects. U.S. macroeconomic information releases -- particularly FOMC announcements -- lead to currency jumps. Using these jump predictors, investors can construct jump robust carry trades to mitigate the left tail risks. The third chapter investigates how jump risks are priced in currency markets. This chapter shows that currencies whose changes are more sensitive to negative market jumps provide significantly higher expected returns. The positive risk premium constitutes compensation for the extreme losses during periods of market turmoil. Using the empirical findings, a jump modified carry trade strategy is proposed, which has approximately two-percentage-point (per annum) higher returns than the regular carry trade strategy. These findings result from the fact that negative jump betas are significantly related to the riskiness of currencies and business conditions.