From the January 01, 2012 issue of Futures Magazine • Subscribe!

Foreign Exchange

Book Review

Foreign Exchange: A Practitioner’s Approach to the Market
Edited by Amy Middleton
Risk Books (Division of Incisive Publishing, Ltc.)
London, 2009; 343 pages

The subtitle of Amy Middleton’s compilation 16 articles, “A Practioner’s Approach to the Market” describes this must-have book for those who trade, invest in, or hedge foreign exchange. Those who already are successful should become more so by reading these articles.

The 19 authors who are portfolio managers (seven), CIOs for fund management companies (three), currency strategists or currency managers (two each), CEOs (two) and a fund manager, a currency overlay manager and a sales manager all head or work for major financial entities from the CalPERS, Harvard Management and The World Bank to BNP Paribas, Millenium, Pareto and PIMCO (with apologies to the eight other firms whose personnel contributed equally worthy articles). None are academics. Collectively, they have some two centuries of FX market experience.

As of publication, Amy Middleton, a risk manager at the Bank of America, has served as a quantitative currency market analyst for institutional clients – hedge funds, pension funds and real money managers – focusing on directional trading models, currency exposures, currency overlay, analyses of currency exposures and formulations of appropriate hedging strategies. It seem safe to assume that all of them have tested what they have written about by direct observation in pursuit of keeping and excelling at their on-the-firing-line jobs.

“What differentiates foreign currency traders from most other traders is that they are liberated from the burden of fundamentalist theories of value and unrealistic assumptions like the efficient markets theory, which accounts for their willingness to use technical analysis,” says Barbara Rockefeller. Her view is justified by her 21-year consistently successful, hypothetical track record trading major currencies as part of her daily Rockefeller Treasury Report.

This view is expressed succinctly by Fatih Yilmaz in Chapter 7, New Generation FX Models: A Practitioner Perspective. “The traditional cyclical models relied on traditional equilibrium arguments and assumed rational expectations and market efficiency. And changes in exchange rates were typically linked to news in fundamental economic variables. Along with the portfolio balance approach, the Mundell-Fleming framework and the dynamic sticky price approach of Dornbusch became the most popular model designed for medium-term (cyclical) currency analysis. However, accumulated evidence suggests that most of the basic assumptions of these models did not hold well in practice. At best it took years and years for the goods market equilibrium to establish (i.e., three-to-five-year half-lives for purchasing power parity model), and the uncovered interest parity assumption failed so miserably that many active currency funds in the industry survived on carry strategies. Movements of exchange rates appear to disconnect significantly from underlying fundamentals and related news….”

This is the right stuff for anyone who wants a clear understanding of how foreign exchange markets work. There are many more similarly useful observations in the four parts of this collection – (I) Currency Risk and Global Macro, (II) Currency Overlay, (III) Alpha Generation, and (IV) Portfolio Allocation. All of them will be useful for anyone who is or wants to be successful in the foreign currency markets.

Desmond MacRae is a New-York-based free-lance writer specializing in institutional banking, finance and investments.

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