Yongmiao Hong (Cornell University and Tsinghua University) Tae-Hwy Lee (University of California, Riverside)
Abstract
It is often documented, based on autocorrelation, variance ratio, and power spectrum, that exchange rates approximately follow a martingale process. Because these data check serial uncorrelatedness rather than martingale difference, they may deliver misleading conclusions in favor of the martingale hypothesis when the test statistics are insignificant. In this paper, we explore whether there exists a gap between serial uncorrelatedness and martingale difference for exchange rate changes, and if so, whether nonlinear time series models admissible in the gap can outperform the martingale model in out-of-sample forecasts. Applying the generalized spectral tests of Hong to five major currencies, we find that the changes of exchange rates are often serially uncorrelated, but there exists strong nonlinearity in conditional mean, in addition to the well-known volatility clustering. To forecast the conditional mean, we consider the linear autoregressive, autoregressive polynomial, artificial neural network, and functional-coefficient models, as well as their combination. The functional coefficient model allows the autoregressive coefficients to depend on investment positions via a moving-average technical trading rule. We evaluate out-of-sample forecasts of these models relative to the martingale model, using four criteria-the mean squared forecast error, the mean absolute forecast error, the mean forecast trading return, and the mean correct forecast direction. White's reality check method is used to avoid data-snooping bias. It is found that suitable nonlinear models, particularly in combination, do have superior predictive ability over the martingale model for some currencies in terms of certain forecast evaluation criteria. Copyright (c) 2003 President and Fellows of Harvard College and the Massachusetts Institute of Technology.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 85 (2003) Issue (Month): 4 (09) Pages: 1048-1062 Download reference. The following formats are available: HTML
(with abstract),
plain text
(with abstract),
BibTeX,
RIS (EndNote, RefMan, ProCite),
ReDIF
For technical questions regarding this item, or to correct its listing, contact: (Christopher F. Baum).
Related research
Keywords:
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Did you know? You can import bibliographic info in various formats into you bibliographic tool, or just into your word processor. See under "publisher info" on each abstract page.