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Arnav Sheth, Saint Mary’s College of California: Leveraging Herd Behavior in Foreign Exchange Markets
January 31, 2017 @ 11:00 am - 12:30 pm
We examine the relationship between equity and foreign exchange markets at, and around, the WM/Reuters benchmark exchange rate known as the the `Fix’. Execution at the Fix is a service offered by brokers (normally banks) provided they obtain the trade order until a certain time prior to 4pm GMT (11 amEastern Time). This benchmark is used to value derivative contracts, measure portfolio tracking error for foreign benchmark equity indexes, and provide a reference exchange rate for purchasing foreign stocks. Given the importance of the Fix in trading both equities and foreign exchange, we hypothesize that equity portfolio managers act in herds and perform most of their trading around the Fix together. Based on this hypothesis, we examine the behavior of exchange rates around the Fix, by testing relationships of equity indexes with dollar-denominated foreign exchange rates. We further hypothesize that this herd behavior can be exploited to create a trading strategy that will provide positive returns. We also observe (a la Melvin and Prins, 2015) that end-of-month behavior of exchange rates is markedly different from the rest of the year, and we find that market rates match up well with the Fix. We further find that we can indeed exploit this herd behavior to provide us with a small, positive profit. We also provide several avenues for further research.