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Multivariate return decomposition: theory and implications
In this paper, we propose a model based on multivariate decomposition of multiplicative?absolute values and signs?components of several returns. In the m-variate case, the marginals for the m absolute values and the binary marginals for the m directions are linked through a 2m-dimensional copula. The approach is detailed in the case of a bivariate decomposition. We outline the construction of the likelihood function and the computation of different conditional measures. The finite-sample properties of the maximum likelihood estimator are assessed by simulation. An application to predicting bond returns illustrates the usefulness of the proposed method.
AUTHORS: Anatolyev, Stanislav; Gospodinov, Nikolay
Foreign exchange predictability during the financial crisis: implications for carry trade profitability
In this paper, we study the effectiveness of carry trade strategies during and after the financial crisis using a flexible approach to modeling currency returns. We decompose the currency returns into multiplicative sign and absolute return components, which exhibit much greater predictability than raw returns. We allow the two components to respond to currency-specific risk factors and use the joint conditional distribution of these components to obtain forecasts of future carry trade returns. Our results suggest that the decomposition model produces higher forecast and directional accuracy than any of the competing models. We show that the forecasting gains translate into economically and statistically significant (risk-adjusted) profitability when trading individual currencies or forming currency portfolios based on the predicted returns from the decomposition model.
AUTHORS: Anatolyev, Stanislav; Gospodinov, Nikolay; Jamali, Ibrahim; Liu, Xiaochun