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The Economic Value of Technical Trading Rules: A Non-parametric Utility-based Approach

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  • Hans Dewachter

    ()
    (K.U.Leuven and Erasmus University Rotterdam)

  • Marco Lyrio

    ()
    (K.U.Leuven, C.E.S., International Economics)

Abstract

We adapt Brandt's (1999) nonparametric approach to determine the optimal portfolio choice of a risk averse foreign exchange investor who uses moving average trading signals as the information instrument for investment opportunities. Additionally, we assess the economic value of the estimated optimal trading rules based on the investor's preferences. The approach consists of a conditional generalized method of moments (GMM) applied to the conditional Euler optimality conditions. The method presents two main advantages: (i) it avoids ad hoc specifications of statistical models used to explain return predictability; and (ii) it implicitly incorporates all return moments in the investor's expected utility maximization problem. We apply the procedure to different moving average trading rules for the German mark- U.S. dollar exchange rate for the period 1973-2001. We find that technical trading rules are partially recovered and that the estimated optimal trading rules represent a significant economic value for the investor.

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Bibliographic Info

Paper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics in its series International Economics Working Papers Series with number ces0203.

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Length: 32 pages
Date of creation: Mar 2002
Date of revision:
Handle: RePEc:kul:kulwps:ces0203

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Keywords: Technical trading ruls; exchange rates; nonparametric methods;

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References

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  1. 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.
  2. Yacine Ait-Sahalia & Michael W. Brandt, 2001. "Variable Selection for Portfolio Choice," NBER Working Papers 8127, National Bureau of Economic Research, Inc.
  3. 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.
  4. Blake LeBaron, . "Do Moving Average Trading Rule Results Imply Nonlinearities in Foreign Exchange?," Working papers _005, University of Wisconsin - Madison.
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Cited by:
  1. Menkhoff, Lukas & Taylor, Mark P., 2006. "The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Leibniz Universität Hannover dp-352, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  2. Isakov, Dusan & Marti, Didier, 2011. "Technical Analysis with a Long-Term Perspective: Trading Strategies and Market Timing Ability," FSES Working Papers 421, Faculty of Economics and Social Sciences, University of Freiburg/Fribourg Switzerland.
  3. Dewachter, Hans & Lyrio, Marco, 2006. "The cost of technical trading rules in the Forex market: A utility-based evaluation," Journal of International Money and Finance, Elsevier, vol. 25(7), pages 1072-1089, November.

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