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Technical Analysis in Foreign Exchange Markets: Linear Versus Nonlinear Trading Rules

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  • Fernando Fernández-Rodríguez
  • Simón Sosvilla-Rivero
  • Julián Andrada-Félix

Abstract

In this paper we assess the economic significance of the nonlinear predictability of EMS exchange rates. To that end, and using daily data for nine EMS currencies covering the 1st January 1978- 31st December 1994 period, we consider nearest-neighbour nonlinear predictors, transforming their forecasts into a technical trading rule, whose profitability has been evaluated against the traditional (linear) moving average trading rules, considering both interest rates and transaction costs. Our results suggest that in most of the cases a trading rule based on a nonlinear predictor outperform the moving average, both in terms of returns and in terms of the ideal profit and the Sharpe ratio profitability indicators.

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Paper provided by FEDEA in its series Working Papers on International Economics and Finance with number 00-02.

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Handle: RePEc:fda:fdadef:00-02

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  1. Blake LeBaron, 1996. "Technical Trading Rule Profitability and Foreign Exchange Intervention," NBER Working Papers 5505, National Bureau of Economic Research, Inc.
  2. William F. Sharpe, 1965. "Mutual Fund Performance," The Journal of Business, University of Chicago Press, vol. 39, pages 119.
  3. Paul Weller & Christopher Neely, 1999. "Technical Analysis and Central Bank Intervention," Working Papers wp99-04, Warwick Business School, Finance Group.
  4. Hardle, W., 1992. "Applied Nonparametric Methods," Papers 9204, Catholique de Louvain - Institut de statistique.
  5. Charles Engel, 1995. "The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence," NBER Working Papers 5312, National Bureau of Economic Research, Inc.
  6. Bryon Higgins, 1993. "Was the ERM crisis inevitable?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 27-40.
  7. Jensen, Michael C., 1978. "Some anomalous evidence regarding market efficiency," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 95-101.
  8. Szakmary, Andrew C. & Mathur, Ike, 1997. "Central bank intervention and trading rule profits in foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 16(4), pages 513-535, August.
  9. Simon Sosvilla-Rivero & Fernando Fernandez-Rodriguez & Oscar Bajo-Rubio, 1999. "Exchange rate volatility in the EMS before and after the fall," Applied Economics Letters, Taylor & Francis Journals, vol. 6(11), pages 717-722.
  10. Brock, W. & Lakonishok, J. & Lebaron, B., 1991. "Simple Technical Trading Rules And The Stochastic Properties Of Stock Returns," Working papers 90-22, Wisconsin Madison - Social Systems.
  11. Fernandez-Rodriguez, Fernando & Sosvilla-Rivero, Simon & Andrada-Felix, Julian, 1999. "Exchange-rate forecasts with simultaneous nearest-neighbour methods: evidence from the EMS," International Journal of Forecasting, Elsevier, vol. 15(4), pages 383-392, October.
  12. Sweeney, Richard J, 1986. " Beating the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 41(1), pages 163-82, March.
  13. Oliver LINTON, . "Applied nonparametric methods," Statistic und Oekonometrie 9312, Humboldt Universitaet Berlin.
  14. Richard Meese & Kenneth Rogoff, 1981. "Empirical exchange rate models of the seventies: are any fit to survive?," International Finance Discussion Papers 184, Board of Governors of the Federal Reserve System (U.S.).
  15. Meese, Richard A & Rose, Andrew K, 1990. "Nonlinear, Nonparametric, Nonessential Exchange Rate Estimation," American Economic Review, American Economic Association, vol. 80(2), pages 192-96, May.
  16. Mizrach, B, 1992. "Multivariate Nearest-Neighbor Forecasts of EMS Exchange Rates," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S151-63, Suppl. De.
  17. Fernandez-Rodriguez, Fernando & Sosvilla-Rivero, Simon, 1998. "Testing nonlinear forecastability in time series: Theory and evidence from the EMS," Economics Letters, Elsevier, vol. 59(1), pages 49-63, April.
  18. C.L. Osler & P.H. Kevin Chang, 1995. "Head and shoulders: not just a flaky pattern," Staff Reports 4, Federal Reserve Bank of New York.
  19. Neftci, Salih N, 1991. "Naive Trading Rules in Financial Markets and Wiener-Kolmogorov Prediction Theory: A Study of "Technical Analysis."," The Journal of Business, University of Chicago Press, vol. 64(4), pages 549-71, October.
  20. Lee, Chun I. & Mathur, Ike, 1996. "Trading rule profits in european currency spot cross-rates," Journal of Banking & Finance, Elsevier, vol. 20(5), pages 949-962, June.
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