Mean aversion and return predictability in currency features

This paper examines two stylized regularities in currency futures traded on the International Money Market. Short horizon returns sampled over the period 1984-1994 exhibit significantly positive autocorrelations at moderate lags. The pattern of autocorrelations in returns is not radically affected when the sample is partitioned into two sub-periods around the 1987 market crash. The positive autocorrelation pattern implies that the increments in currency futures prices are not consistent with the random walk hypothesis. Instead, it is consistent with an investor's fads model, in which deviations in prices exhibit persistence for a long period. A GARCH prediction model based on the fads process is explored in which the spot exchange rate serves as a proxy for the fundamental for the currency features.