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

  • Fernando Fernández-Rodríguez

    (Universidad de Las Palmas de Gran Canaria)

  • Simón Sosvilla-Rivero

    (FEDEA and Universidad Complutense de Madrid)

  • Julián Andrada-Félix

    (Universidad de Las Palmas de Gran Canaria)

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 Asociación Española de Economía y Finanzas Internacionales in its series Working Papers with number 00-02.

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Length: 21 pages
Date of creation: Sep 2000
Date of revision:
Handle: RePEc:aee:wpaper:0002
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  1. 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.
  2. 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.
  3. LeBaron, Blake, 1999. "Technical trading rule profitability and foreign exchange intervention," Journal of International Economics, Elsevier, vol. 49(1), pages 125-143, October.
  4. 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.
  5. Carol L. Osler & P.H. Kevin Chang, 1995. "Head and shoulders: not just a flaky pattern," Staff Reports 4, Federal Reserve Bank of New York.
  6. 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.
  7. 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.
  8. Hardle, Wolfgang & Linton, Oliver, 1986. "Applied nonparametric methods," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 38, pages 2295-2339 Elsevier.
  9. 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.
  10. Christopher J. Neely & Paul A. Weller, 2000. "Technical analysis and central bank intervention," Working Papers 1997-002, Federal Reserve Bank of St. Louis.
  11. William F. Sharpe, 1965. "Mutual Fund Performance," The Journal of Business, University of Chicago Press, vol. 39, pages 119.
  12. Bryon Higgins, 1993. "Was the ERM crisis inevitable?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 27-40.
  13. Sweeney, Richard J, 1986. " Beating the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 41(1), pages 163-82, March.
  14. 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.
  15. Richard Meese & Kenneth S. 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.).
  16. 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.
  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. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
  19. Jensen, Michael C., 1978. "Some anomalous evidence regarding market efficiency," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 95-101.
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