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The economic value of technical trading rules: a nonparametric utility-based approach

  • Hans Dewachter
  • Marco Lyrio

    (CES, Catholic University of Leuven, Belgium)

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-US 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. Copyright © 2005 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.256
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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 10 (2005)
Issue (Month): 1 ()
Pages: 41-62

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Handle: RePEc:ijf:ijfiec:v:10:y:2005:i:1:p:41-62
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  1. Yacine Ait-Sahalia & Michael W. Brandt, 2001. "Variable Selection for Portfolio Choice," NBER Working Papers 8127, National Bureau of Economic Research, Inc.
  2. 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.
  3. Blake LeBaron, . "Do Moving Average Trading Rule Results Imply Nonlinearities in Foreign Exchange?," Working papers _005, University of Wisconsin - Madison.
  4. 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.
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