۱٫ Introduction

۲٫ Data and methodology

۳٫ Empirical results

۴٫ Conclusion

Appendix. Descriptive statistics, regime classifications and profitability of arbitrage.

References

Abstract

In this study, we investigate monthly seasonality in the foreign exchange market. Given the well-known recurrent higher returns in some month than in others in stock markets around the world, we consider it likely that a seasonal outperformance of a country’s stock market over another is associated with similar seasonal patterns in capital flows and exchange rates. A seasonal profit (carry trade) opportunity can be created by the simultaneous appreciation of a country’s currency and the outperformance of its stock market. By focusing on the world’s key currency pairs, the US dollar-Deutsche mark and the US dollar-euro, and by using a Markov-switching framework, we document persistent January and December effects in the foreign exchange market from 1971 to 2017. Analysis of the German-US stock returns differential and their bilateral capital flows reveal similar month effects in 65% of the whole sample.

Introduction

A rarely explored feature of exchange rates is their persistent monthly seasonality. According to the informationally-efficient market hypothesis (Fama, 1970), calendar regularities, such as higher foreign exchange gains in a specific month, should already be included in asset prices. Profit opportunities associated with such regularities represent calendar anomalies and violate informational efficiency (Fama, 1970). The persistence of such a violation should not be surprising in light of the persistent January effect in most stock markets, which has still not been arbitraged away. However, it is difficult to understand why researchers of foreign currency markets have never related their findings to those of stock market experts. Indeed, since there is only limited evidence of seasonality in bond yields1 for old samples, the January effect in the returns differential between two countries’ stock markets is the main candidate to rationalize the similar seasonality in their currency pair. The natural conduit between these markets is seasonal equity capital flows, the engine of equity carry trades.2 Such relationships have been studied at a general level in the literature on uncovered equity parity,3 but no attention has been granted to their possible seasonal character. The reason why known seasonalities in these markets are not fully arbitraged away is that they take place most of the time, but not all the time. In other words, they are non-linear, occurring in some regimes but not in others.

We pursue three objectives in this study. First, we aim to revisit the presence of monthly seasonality in the foreign exchange market and its non-linear character. Second, we examine the monthly seasonal behavior of the corresponding stock returns differential in a similar non-linear framework. We gauge the synchronicity and the similarity of the seasonal patterns of the exchange rate returns and the stock returns differential. Third, to explore the transmission channel of equity carry trade opportunities, we investigate whether this seasonal synchronicity is reflected in the seasonal pattern of the bilateral equity flows.