Jump Risk, Time-Varying Risk Premia, and Technical Trading Profits

Federal Reserve Bank of Atlanta 97-17

10 Pages Posted: 14 May 1998

See all articles by Chenyang Feng

Chenyang Feng

Providian Financial Corporation - Credit Group

Stephen D. Smith

(Deceased)

Date Written: November 1997

Abstract

In this paper we investigate the recently documented trading profits based on technical trading rules in an asset pricing framework that incorporates jump risk and time-varying risk premia. Following Brock, Lakonishok, and LeBaron (1992), we apply popular technical trading rules to the daily S&P 500 index over a long period of time. Trading profits are examined using bootstrap simulation to address distributional anomalies. We estimate a variety of asset pricing models, including the random walk, autoregressive models, a combined jump diffusion model, and a combined model of jump-diffusion and autoregressive conditional heteroscedasticity. Technical trading profits are shown to be statistically significant for the pure diffusion models and autoregressive models, yet become less significant when jump risk is incorporated into the model and virtually disappear for an asset pricing model that incorporates both jump risk and time-varying risk premia. The empirical evidence suggests that technical trading profits could be fair compensation for the risk of price discontinuity as well as time-varying risk premia of asset returns. Alternatively, technical trading profits provide a test of specification of asset pricing models; in this vein the evidence provides support for the incorporation of jump risk into asset pricing models.

JEL Classification: G12, G14

Suggested Citation

Feng, Chenyang and Smith, Stephen Dewitt, Jump Risk, Time-Varying Risk Premia, and Technical Trading Profits (November 1997). Federal Reserve Bank of Atlanta 97-17. Available at SSRN: https://ssrn.com/abstract=87068 or http://dx.doi.org/10.2139/ssrn.87068

Chenyang Feng (Contact Author)

Providian Financial Corporation - Credit Group ( email )

San Francisco, CA 94105
United States
415-278-4107 (Phone)
415-278-6013 (Fax)

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