Technical Analysis in Foreign Exchange Markets: Linear Versus Nonlinear Trading Rules
FEDEA Int. Economics & Finance DEFI Working Paper No. 00-02
21 Pages Posted: 27 Jul 2001
Date Written: September 2000
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 outperforms the moving average, both in terms of returns and in terms of the ideal profit and the Sharpe ratio profitability indicators.
Keywords: Nearest-neighbour prediction methods, Technical trading rules, Exchange rates
JEL Classification: C53, F31
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