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Optimal transaction filters under transitory trading opportunities: Theory and empirical illustration

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  • Balvers, Ronald
  • Wu, Yangru

Abstract

If transitory profitable trading opportunities exist, transaction filters mitigate trading costs. We use a dynamic programming framework to design an optimal filter that maximizes after-cost expected returns. The filter size depends crucially on the degree of persistence of trading opportunities, transaction cost, and standard deviation of shocks. For daily dollar-yen exchange trading, the optimal filter can be economically significantly different from a naïve filter equal to the transaction cost. The candidate trading strategies generate positive returns that disappear after transaction costs. However, when the optimal filter is used, returns after costs remain positive and higher than for naïve filters.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Markets.

Volume (Year): 13 (2010)
Issue (Month): 1 (February)
Pages: 129-156

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Handle: RePEc:eee:finmar:v:13:y:2010:i:1:p:129-156

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Web page: http://www.elsevier.com/locate/finmar

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Keywords: Transaction costs Transaction filters Trading strategies Foreign exchange;

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References

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Cited by:
  1. Imad Moosa, 2011. "The profitability of interest arbitrage when the base currency is pegged to a basket," Review of Quantitative Finance and Accounting, Springer, vol. 37(3), pages 267-281, October.
  2. : Roman Kozhan & Mark Salmon, 2010. "The information Content of a Limit Order Book:the Case of an FX Market," Working Papers wpn10-05, Warwick Business School, Finance Group.

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