Can Markov switching models predict excess foreign exchange returns?

Michael Dueker and Christopher Neely

No 2001-021, Working Papers from Federal Reserve Bank of St. Louis

Abstract: 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.

Keywords: Foreign exchange; Forecasting (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-ets, nep-fin and nep-ifn
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Citations: View citations in EconPapers (27)

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DOI: 10.20955/wp.2001.021

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