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Spurious Regressions in Technical Trading: Momentum or Contrarian?

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Author Info
Mototsugu Shintani (Department of Economics, Vanderbilt University, and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: mototsugu.shintani@vanderbilt.edu, mototsugu.shintani@boj.or.jp))
Tomoyoshi Yabu (Assistant Professor, Graduate School of Systems and Information Engineering, University of Tsukuba (E-mail: tyabu@sk.tsukuba.ac.jp))
and Daisuke Nagakura (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: daisuke.nagakura@boj.or.jp))

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Abstract

This paper investigates the spurious effect in forecasting asset returns when signals from technical trading rules are used as predictors. Against economic intuition, the simulation result shows that, even if past information has non predictive power, buy or sell signals based on the difference between the short-period and long-period moving averages of past asset prices can be statistically significant when the forecast horizon is relatively long. The theory implies that both e momentumf and econtrarianf strategies can be falsely supported, while the probability of obtaining each result depends on the type of the test statistics employed. Several modifications to these test statistics are considered for the purpose of avoiding spurious regressions. They are applied to the stock market index and the foreign exchange rate in order to reconsider the predictive power of technical trading rules.

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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 08-E-9.

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Date of creation: Jun 2008
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Handle: RePEc:ime:imedps:08-e-9

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Related research
Keywords: Efficient market hypothesis; Nonstationary time series; Random walk; Technical analysis;

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Find related papers by JEL classification:
C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
C25 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Discrete Regression and Qualitative Choice Models
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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