Foreign Exchange Market Shocks in the Context of the Global Pandemic (COVID-19)

Introduction

The market efficiency hypothesis is a very relevant concept for international investors who want to have their portfolios diversified to mitigate the inherent risk of global financial markets. With the global economy becoming increasingly integrated, international investors have sought to diversify their portfolios into more exotic markets in different ways, with the goal that their asset synchronizations are low. Testing the synchronizations between markets and inferring the existence of portfolio diversification hypotheses when markets are not integrated may give rise to distorted evidence. We have seen a strong correlation between past and future data series, which makes it possible for an investor to have anomalous returns when selecting an appropriate trading strategy. The possibility that investors can predict future price changes could cause imbalances in financial markets making it difficult to implement efficient portfolio diversification strategies (Alexandre, Dias, and Heliodoro, 2020; Alexandre, Heliodoro, and Dias, 2019; Dias, R. and Pereira, 2020; Dias, R. and Carvalho, 2020; Dias, da Silva, and Dionisio, 2019; Dias, Heliodoro, Alexandre, Santos, and Farinha, 2021; Dias, Heliodoro, Alexandre, et al, 2020a; Dias, Heliodoro, Alexandre, & Vasco, 2020b; Dias, Heliodoro, Alexandre, et al., 2020a; Dias, Heliodoro, Teixeira, and Godinho, 2020; Dias, Pardal, Teixeira, and Machová, 2020; Dias, Teixeira, Machova, et al., 2020; Heliodoro, Dias, and Alexandre, 2020; Heliodoro, Dias, Alexandre, and Vasco, 2020; Pardal, Dias, Šuleř, Teixeira, and Krulický, 2020).

Different studies have analyzed the issue of market efficiency, examining the hypothesis of predictability of returns, through the analysis of the reversion to the average in the prices of financial markets (Fama and French, 1988). When the hypotheses of random walk and informational efficiency are rejected, they cause extreme movements in stock prices. The occurrence of these phenomena may, eventually, decrease the implementation of efficient portfolio diversification strategies (Malafeyev, Awasthi, S. Kambekar, and Kupinskaya, 2019; Sadat and Hasan, 2019).

Speculation is part of the process of price discovery and that efforts to reduce such speculation significantly reduces information efficiency in the foreign exchange markets. In view of these events this chapter aims to test the efficiency, in its weak form, among the foreign exchange markets, EUR.GBP, EUR.JPY, EUR.USD, GBP.USD, JPY.CHF, USD.BTC, USD.CAD, USD.CHF, USD.JPY, USD.JPY, USD.BRL, in order to assess whether these foreign exchange markets have robust hedging and diversification characteristics. In order to conduct this analysis, different approaches were undertaken to assess whether: (i) in periods of high volatility, do foreign exchange markets tend to integrate? (ii) whether the global pandemic accentuates (in) efficiency in international foreign exchange markets? The results suggest that the foreign exchange markets are mostly integrated (63 out of 90 possible), which may jeopardize portfolio diversification. The results of the exponents Detrended Fluctuation Analysis (DFA), show that the foreign exchange markets reject, in the majority, the random walk hypothesis. These findings have implications for investors, since some returns can be expected, creating opportunities for arbitrage and abnormal earnings.