currency overlay Active currency overlay requires management style decisions on the part of the manager, based on the types of model and model input that the manager chooses to employ. While these decisions are often real-time, some providers develop pre-defined rule based strategies. The most common categories in active currency overlay are as follows: Fundamental Technical Dynamic Option-based Fundamental managers believe they can exploit price inefficiencies using models and processes in which economic and financial data are used as the ‘exogenous’ variables, including balance of payments, capital flows, price levels, monetary conditions, etc. Technical managers tend to ignore completely external economic variables, and argue that price and price history provide the most effective mechanism for exploiting inefficiencies. A typical approach would be to model price history to determine successful trading rules. Dynamic managers are a group that aims to create an asymmetric return—running profits and cutting losses—with forwards or option technology. Option-based managers exploit systematic differences between implied and actual future volatility. Currency for return The foreign exchange market exhibits systematic inefficiencies, owing mostly to its unique status among financial markets: only a small proportion of currency market participants are seeking profit in that market. Instead, most participants transact in the foreign exchange markets for other purposes—trade or investment, for instance. Because the market is dominated by highly constrained participants like industrial and commercial companies, fund managers, portfolio investors, and central banks, there still exist arbitrage opportunities that are not fully exploited. These include cyclical behaviour, trending, disparities in implied and actual volatility, and the forward rate bias. Bibliography Harris, Louise (2006). Currency Overlay: An Introduction Record, Neil (2003). Currency Overlay (The Wiley Finance Series) Smith, Ralph (2003). Currency Hedging for European investors Xin, Dr Hai (2003). Currency Overlay - A Practical Guide Book (UBS). References Foreign exchange market