FX Premia Around the Clock

We dissect return dynamics in the foreign exchange market into high-frequency components over the 24-hour day. Using twenty-four years of data on G10 currencies we show that the dollar portfolio follows a systematic ‘W’ shaped return pattern over the trading day. Between U.S. closing and Asian opening the dollar appreciates, in Asian trading hours the dollar depreciates, between European opening and U.S. opening hours the dollar appreciates while during regular U.S trading hours the dollar depreciates. The net effect of this pattern is that investors obtain positive average returns for going long foreign currencies during U.S. trading hours, whereas overnight returns are negative. Exploiting a risk premium decomposition, we show that long and short legs of carry and dollar carry strategies also follow a ‘W’ shaped intraday return pattern, albeit with loadings that generate orthogonal components. Tracking these returns throughout the day we find that 75% of carry profits are generated U.S. hours whereas 100% of dollar carry returns are generated during European trading hours. Finally, we show these patterns are exploitable by a subset of investors, such as market makers and large institutional investors, who face lower than average transaction costs.