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Working Paper
Predictability in international asset returns: a reexamination
This paper argues that inferring long-horizon asset-return predictability from the properties of vector autoregressive (VAR) models on relatively short spans of data is potentially unreliable. We illustrate the problems that can arise by re-examining the findings of Bekaert and Hodrick (1992), who detected evidence of in-sample predictability in international equity and foreign exchange markets using VAR methodology for a variety of countries over the period 1981-1989. The VAR predictions are significantly biased in most out-of-sample forecasts and are conclusively outperformed by a simple ...
Working Paper
Can risk explain the profitability of technical trading in currency markets?
Academic studies show that technical trading rules would have earned substantial excess returns over long periods in foreign exchange markets. However, the approach to risk adjustment has typically been rather cursory. We examine the ability of a wide range of models: CAPM, quadratic CAPM, downside risk CAPM, C-CAPM, Carhart?s 4-factor model, an extended C-CAPM with durable consumption, Lustig-Verdelhan (LV) factors, volatility, skewness and liquidity to explain these technical trading returns. No model plausibly accounts for a substantial amount of technical profitability in the foreign ...
Working Paper
Central bank intervention with limited arbitrage
Shleifer and Vishny (1997) pointed out some of the practical and theoretical problems associated with assuming that rational risk-arbitrage would quickly drive asset prices back to long-run equilibrium. In particular, they showed that the possibility that asset price disequilibrium would worsen, before being corrected, tends to limit rational speculators. Uniquely, Shleifer and Vishny (1997) showed that ?performance-based asset management? would tend to reduce risk-arbitrage when it is needed most, when asset prices are furthest from equilibrium. We analyze a generalized Shleifer and Vishny ...
Working Paper
Technical analysis and central bank intervention
This paper extends the genetic programming techniques developed in Neely, Weller and Dittmar (1997) to show that technical trading rules can make use of information about U.S. foreign exchange intervention to improve their out-of-sample profitability for two of four exchange rates. Rules tend to take positions contrary to official intervention and are unusually profitable on days prior to intervention, indicating that intervention is intended to check or reverse predictable trends. Intervention seems to be more successful in checking predictable trends in the out-of-sample (1981-1996) period ...
Working Paper
Lessons from the evolution of foreign exchange trading strategies
The adaptive markets hypothesis posits that trading strategies evolve as traders adapt their behavior to changing circumstances. This paper studies the evolution of trading strategies for a hypothetical trader who chooses portfolios from foreign exchange (forex) technical rules in major and emerging markets, the carry trade, and U.S. equities. The results show that forex trading alone dramatically outperforms the S&P 500 but there is little gain to coordinating forex and equity strategies, which explains why practitioners consider these tools separately. In addition, a backtesting procedure ...
Working Paper
Predicting exchange rate volatility: genetic programming vs. GARCH and RiskMetrics
This article investigates the use of genetic programming to forecast out-of-sample daily volatility in the foreign exchange market. Forecasting performance is evaluated relative to GARCH(1,1) and RiskMetrics models for two currencies, DEM and JPY. Although the GARCH/RiskMetrics models appear to have a inconsistent marginal edge over the genetic program using the mean-squared-error (MSE) and R2 criteria, the genetic program consistently produces lower mean absolute forecast errors (MAE) at all horizons and for both currencies.
Working Paper
The adaptive markets hypothesis: evidence from the foreign exchange market
We analyze the intertemporal stability of excess returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously studied rules. The excess returns of the 1970s and 1980s were genuine and not just the result of data mining. But these profit opportunities had disappeared by the early 1990s for filter and moving average rules. Returns to less-studied rules also have declined but have probably not completely disappeared. High volatility prevents precise estimation of mean returns. These regularities are consistent with the Adaptive Markets ...
Working Paper
Is technical analysis in the foreign exchange market profitable? a genetic programming approach
Using genetic programming techniques to find technical trading rules, we find strong evidence of economically significant out-of-sample excess returns to those rules for each of six exchange rates, over the period 1981-1995. Further, when the dollar/deutschemark rules are allowed to determine trades in the other markets, there is a significant improvement in performance in all cases, except for the deutschemark/yen. Betas calculated for the returns according to various benchmark portfolios provide no evidence that the returns to these rules are compensation for bearing systematic risk. ...
Working Paper
Technical trading rules in the European Monetary System
Using the genetic programming methodology developed in Neely, Weller and Dittmar (1997), we find trading rules that generate significant excess returns for three of four EMS exchange rates over the out-of-sample period 1986-1996. Permitting the rules to use information about the interest rate differential proved to be important. The reduction in volatility resulting from the imposition of a narrower band may reduce trading rule profitability. The currency for which there was least evidence of significant excess returns was the Dutch guilder, which was also the only currency that remained ...
Working Paper
Technical analysis in the foreign exchange market
This article introduces the subject of technical analysis in the foreign exchange market, with emphasis on its importance for questions of market efficiency. Technicians view their craft, the study of price patterns, as exploiting traders? psychological regularities. The literature on technical analysis has established that simple technical trading rules on dollar exchange rates provided 15 years of positive, risk-adjusted returns during the 1970s and 80s before those returns were extinguished. More recently, more complex and less studied rules have produced more modest returns for a similar ...