SEF Working paper: 05/2014
33 Pages Posted: 16 May 2017
Date Written: May 8, 2014
An immediate consequence of the Efficient Market Hypothesis (EMH) is the absence of auto-correlation of the return series of the financial prices and the exclusion of excess profitability made by any (active) trading strategy. However, the precondition for the validity of EMH, which assumes that all market participants can promptly receive and rationally react to the relevant information affecting the prices, might be (approximately) true for a long time horizon, but not for a short time horizon. By examining local long-range dependence (measured by the rolling Rescaled Range estimates of the Hurst index) of an empirical example, the local market inefficiency is inferred, and excess profitability of a simple trend-following trading strategy is observed. Moreover, the significant positive cross-correlation between the local Hurst index estimates and the returns of the trend-following trading strategies implies the potential for constructing a more profitable trading system by incorporating the former into the latter.
Keywords: High-frequency trading, Hurst index, Long memory, Market efficiency, Rescaled range analysis, Trading system
JEL Classification: G17, G20, C13
Suggested Citation: Suggested Citation
Vo, Long Hai and Roberts, Leigh, On Long Memory Behaviour and Predictability of Financial Markets (May 8, 2014). SEF Working paper: 05/2014 . Available at SSRN: https://ssrn.com/abstract=2968753 or http://dx.doi.org/10.2139/ssrn.2968753