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The adaptive markets hypothesis: evidence from the foreign exchange market

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Author Info
Christopher J. Neely
Paul A. Weller
Joshua M. Ulrich

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Abstract

We analyze the intertemporal stability of excess returns to technical trading rules in the foreign exchange market by conducting true, out-of-sample tests on previously studied rules. The excess returns of the 1970s and 1980s were genuine and not just the result of data mining. But these profit opportunities had disappeared by the early 1990s for filter and moving average rules. Returns to less-studied rules also have declined but have probably not completely disappeared. High volatility prevents precise estimation of mean returns. These regularities are consistent with the Adaptive Markets Hypothesis (Lo, 2004), but not with the Efficient Markets Hypothesis.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2006-046.

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Date of creation: 2007
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Handle: RePEc:fip:fedlwp:2006-046

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Keywords: Foreign exchange market ; Foreign exchange;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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.:
  1. Sweeney, Richard J, 1986. " Beating the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 41(1), pages 163-82, March. [Downloadable!] (restricted)
  2. Levich, Richard M. & Thomas, Lee III, 1993. "The significance of technical trading-rule profits in the foreign exchange market: a bootstrap approach," Journal of International Money and Finance, Elsevier, vol. 12(5), pages 451-474, October. [Downloadable!] (restricted)
  3. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-95, June. [Downloadable!] (restricted)
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  4. Menkhoff, Lukas, 1997. "Examining the Use of Technical Currency Analysis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(4), pages 307-18, October. [Downloadable!] (restricted)
  5. Menkhoff, Lukas & Taylor, Mark P., 2006. "The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-352, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
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  6. 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. [Downloadable!]
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  7. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 11(3), pages 304-314, June. [Downloadable!] (restricted)
  8. Ghysels, Eric & Guay, Alain & Hall, Alastair, 1998. "Predictive tests for structural change with unknown breakpoint," Journal of Econometrics, Elsevier, vol. 82(2), pages 209-233, February. [Downloadable!] (restricted)
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  9. Sullivan, Ryan & Timmermann, Allan G & White, Halbert, 1998. "Data-Snooping, Technical Trading Rule Performance and the Bootstrap," CEPR Discussion Papers 1976, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Martin, Anna D., 2001. "Technical trading rules in the spot foreign exchange markets of developing countries," Journal of Multinational Financial Management, Elsevier, vol. 11(1), pages 59-68, February. [Downloadable!] (restricted)
  11. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March. [Downloadable!] (restricted)
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  12. Michael Dueker & Christopher J. Neely, 2006. "Can Markov switching models predict excess foreign exchange returns?," Working Papers 2001-021, Federal Reserve Bank of St. Louis. [Downloadable!]
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  13. Halbert White, 2000. "A Reality Check for Data Snooping," Econometrica, Econometric Society, vol. 68(5), pages 1097-1126, September.
  14. 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. [Downloadable!] (restricted)
  15. Olson, Dennis, 2004. "Have trading rule profits in the currency markets declined over time?," Journal of Banking & Finance, Elsevier, vol. 28(1), pages 85-105, January. [Downloadable!] (restricted)
  16. Cheung, Yin-Wong & Wong, Clement Yuk-Pang, 2000. "A survey of market practitioners' views on exchange rate dynamics," Journal of International Economics, Elsevier, vol. 51(2), pages 401-419, August. [Downloadable!] (restricted)
  17. Frenkel, Jacob A & Levich, Richard M, 1977. "Transaction Costs and Interest Arbitrage: Tranquil versus Turbulent Periods," Journal of Political Economy, University of Chicago Press, vol. 85(6), pages 1209-26, December. [Downloadable!] (restricted)
  18. G. William Schwert, 2002. "Anomalies and Market Efficiency," NBER Working Papers 9277, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. 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. [Downloadable!] (restricted)
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  20. Bertrand Maillet, Thierry Michel, 2000. "Further insights on the puzzle of technical analysis profitability," European Journal of Finance, Taylor and Francis Journals, vol. 6(2), pages 196-224, June. [Downloadable!] (restricted)
  21. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-56, July. [Downloadable!] (restricted)
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  22. Cheung, Yin-Wong & Chinn, Menzie D., 2000. "Currency Traders and Exchange Rate Dynamics: A Survey of the U.S. Market," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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Full references

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.)

  1. Stephan Schulmeister, 2007. "The Interaction Between the Aggregate Behaviour of Technical Trading Systems and Stock Price Dynamics," WIFO Working Papers 290, WIFO. [Downloadable!]
  2. Rime, Dagfinn & Sarno, Lucio & Sojli, Elvira, 2009. "Exchange Rate Forecasting, Order Flow and Macroeconomic Information," CEPR Discussion Papers 7225, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Richard M. Levich & Valerio Poti, 2008. "Predictability and 'Good Deals' in Currency Markets," NBER Working Papers 14597, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Menkhoff, Lukas & Taylor, Mark P., 2006. "The Obstinate Passion of Foreign Exchange Professionals : Technical Analysis," The Warwick Economics Research Paper Series (TWERPS) 769, University of Warwick, Department of Economics. [Downloadable!]
    Other versions:
  5. Zwart, G.J. de & Markwat, T.D. & Swinkels, L. & Dijk, D.J.C. van, 2007. "The Economic Value of Fundamental and Technical Information in Emerging Currency Markets," Research Paper ERS-2007-096-F&A Revision, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni. [Downloadable!]
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  6. Momtchil Pojarliev & Richard M. Levich, 2008. "Trades of the Living Dead: Style Differences, Style Persistence and Performance of Currency Fund Managers," NBER Working Papers 14355, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Nikola Gradojevic & Christopher J. Neely, 2008. "The dynamic interaction of order flows and the CAD/USD exchange rate," Working Papers 2008-006, Federal Reserve Bank of St. Louis. [Downloadable!]
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