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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. Christopher J. Neely & Paul A. Weller & Robert Dittmar, 1997. "Is technical analysis in the foreign exchange market profitable? a genetic programming approach," Working Papers 1996-006, Federal Reserve Bank of St. Louis.
  2. 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.
  3. LeBaron, Blake, 1999. "Technical trading rule profitability and foreign exchange intervention," Journal of International Economics, Elsevier, vol. 49(1), pages 125-143, October.
  4. Spyros Skouras, 2000. "Risk Neutral Forecasting," Computing in Economics and Finance 2000 117, Society for Computational Economics.
  5. 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.
  6. S. Skouras, 2001. "Learning to profit with discrete investment rules," Quantitative Finance, Taylor and Francis Journals, vol. 1(2), pages 284-288.
  7. Dewachter, Hans & Lyrio, M, 2002. "The economic value of technical trading rules: A nonparametric utility-based approach," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/121583, Katholieke Universiteit Leuven.
  8. Blake LeBaron, . "Do Moving Average Trading Rule Results Imply Nonlinearities in Foreign Exchange?," Working papers _005, University of Wisconsin - Madison.
  9. Gencay, Ramazan, 1999. "Linear, non-linear and essential foreign exchange rate prediction with simple technical trading rules," Journal of International Economics, Elsevier, vol. 47(1), pages 91-107, February.
  10. 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.
  11. 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.
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Cited by:
  1. 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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