The strategy trades CNH/USD using a predictive linear model, leveraging exchange rate, volatility, and equity premiums. Positions are adjusted daily based on forecasts and rebalanced for optimal performance.
ASSET CLASS: CFDs, futures | REGION: China | FREQUENCY:
Daily | MARKET: currencies | KEYWORD: Predictability, USD/CNH
I. STRATEGY IN A NUTSHELL
The strategy trades CNH/USD using a linear model to predict daily currency changes, taking long or short positions based on forecasts and rebalancing daily.
II. ECONOMIC RATIONALE
CNH-CNY deviations, driven by PBoC interventions and market liberalization, create exploitable opportunities; linear models using parity, volatility, and premium measures effectively forecast short-term CNH movements.
III. SOURCE PAPER
Chinese Exchange Rate Policy: Lessons for Global Investors [Click to Open PDF]
Michael Melvin, Rady School of Management, University of California San Diego, USA; Frank Westermann, Institute of Empirical Economic Research, Osnabrück University, Germany
<Abstract>
Chinese currency policy has had a strong impact on the value of investors’ portfolios in recent years. On August 11, 2015, the People’s Bank of China announced a new exchange rate policy where the RMB central parity rate against the USD would be determined each morning by the previous day’s closing rate, market demand and supply, and valuations of other currencies. This new policy suggests an implementable investment strategy for trading the CNH. In this paper we create a forecasting model based on information regarding the central parity rate, implied volatilities and other control variables which correctly predicts the direction of change on about 60 percent of days. The exchange rate forecast is then used to manage the global investor’s problem of mitigating the currency risk inherent in Chinese equity positions. All currency hedging strategies are shown to add value to the equity portfolio. A dynamic currency overlay strategy, where the forecasting model is used as a trading signal to take long and short positions in CNH, performs particularly well.
IV. BACKTEST PERFORMANCE
| Annualised Return | 26.1% |
| Volatility | 4% |
| Beta | N/A |
| Sharpe Ratio | 6.53 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | N/A |
