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The cost of technical trading rules in the Forex market: A utility-based evaluation

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  • Dewachter, Hans
  • Lyrio, Marco

Abstract

We compute the opportunity cost for rational risk averse agents of using technical trading rules in the foreign exchange rate market. Our purpose is to investigate whether these rules can be interpreted as near-rational investment strategies for rational investors. We analyze four di.erent exchange rates and find that the opportunity cost of using chartist rules tends to be prohibitively high. We also present a method to decompose this opportunity cost into parts related to investor's irrationality and misallocation of wealth. The results show that irrationality of chartist beliefs is an important component of the total opportunity cost of using technical trading rules.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 25 (2006)
Issue (Month): 7 (November)
Pages: 1072-1089

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Handle: RePEc:eee:jimfin:v:25:y:2006:i:7:p:1072-1089

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Web page: http://www.elsevier.com/locate/inca/30443

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References

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  1. Dittmar, Robert & Neely, Christopher J & Weller, Paul, 1996. "Is Technical Analysis in the Foreign Exchange Market Profitable? A Genetic Programming Approach," CEPR Discussion Papers 1480, C.E.P.R. Discussion Papers.
  2. Michael W. Brandt, 1999. "Estimating Portfolio and Consumption Choice: A Conditional Euler Equations Approach," Journal of Finance, American Finance Association, vol. 54(5), pages 1609-1645, October.
  3. Skouras, Spyros, 2001. "Financial returns and efficiency as seen by an artificial technical analyst," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 213-244, January.
  4. Hans Dewachter & Marco Lyrio, 2002. "The Economic Value of Technical Trading Rules: A Non-parametric Utility-based Approach," International Economics Working Papers Series ces0203, Katholieke Universiteit Leuven, Centrum voor Economische Studiƫn, International Economics.
  5. Blake LeBaron, . "Technical Trading Rule Profitability and Foreign Exchange Intervention," Working papers _002, University of Wisconsin - Madison.
  6. Brock, William & Lakonishok, Josef & LeBaron, Blake, 1992. " Simple Technical Trading Rules and the Stochastic Properties of Stock Returns," Journal of Finance, American Finance Association, vol. 47(5), pages 1731-64, December.
  7. S. Skouras, 2001. "Learning to profit with discrete investment rules," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 284-288.
  8. Dewachter, Hans, 2001. "Can Markov switching models replicate chartist profits in the foreign exchange market?," Journal of International Money and Finance, Elsevier, vol. 20(1), pages 25-41, February.
  9. Spyros Skouras, 2001. "Risk Neutral Forecasting," Computing in Economics and Finance 2001 50, Society for Computational Economics.
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Cited by:
  1. Paresh Kumar Narayan & Seema Narayan & Susan S Sharma, . "An analysis of commodity markets: What gain for investors?," Financial Econometics Series 2013_02, Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance.
  2. Massimo Guidolin & Daniel L. Thornton, 2010. "Predictions of short-term rates and the expectations hypothesis," Working Papers 2010-013, Federal Reserve Bank of St. Louis.

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