Currency momentum: an emerging market issue?

Three main currency strategies have been established in the literature: carry, value, and momentum. We investigate momentum using data on 27 currencies (10 developed countries and 17 emerging markets). We find that momentum returns are driven by emerging market currencies, while the currencies of developed countries have no impact. An emerging market- specific dollar risk factor can partly explain these momentum returns. We carry out permutation tests and find support for our hypothesis that momentum returns are driven by emerging markets. However, we show that transaction costs reduce momentum returns considerably. We also show that the returns are time-varying and have been unattractive recently. The implications of this study for financial practitioners are to focus on emerging market currencies and optimise transaction costs when executing momentum strategies.