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Working Paper 2001-021F

"Can Markov Switching Models Predict Excess Foreign Exchange Returns?"
by Michael J. Dueker, and Christopher J. Neely

This paper merges the literature on technical trading rules with the literature on Markov switching to develop economically useful trading rules. The Markov models' out-of sample, excess returns modestly exceed those of standard technical rules and are profitable over the most recent subsample. A portfolio of Markov and standard technical rules outperforms either set individually, on a risk-adjusted basis. The Markov rules' high excess returns contrast with mixed performance on statistical tests of forecast accuracy. There is no clear source for the trends, but permitting the mean to depend on higher moments of the exchange rate distribution modestly increases returns.

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Category > Applied Econometrics
Category > Finance
Category > International
Author > Michael J. Dueker
Author > Christopher J. Neely
Research Papers and Publications: JEL Code > F31
Research Papers and Publications: JEL Code > G15