Optimal Transaction Filters Under Transitory Trading Opportunities: Theory and Empirical Illustration

Ronald Balvers and Yangru Wu ()

No 22005, Working Papers from Hong Kong Institute for Monetary Research

Abstract: If transitory profitable trading opportunities exist, filter rules are used to mitigate transaction costs. We use a dynamic programming framework to design an optimal filter which maximizes after-cost expected returns. The filter size depends crucially on the degree of persistence of trading opportunities, transaction cost, and standard deviation of shocks. Applying our theory to daily dollar-yen exchange trading, we find that the optimal filter can be economically significantly different from a naive filter equal to the transaction cost. The candidate trading strategies generate positive returns that disappear after accounting for transaction costs. However, when the optimal filter is used, returns after costs remain positive and are higher than for naive filters.

Keywords: Transaction Costs; Filter Rules; Trading Strategies; Foreign Exchange (search for similar items in EconPapers)
JEL-codes: G10 G11 G15 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2005-02
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Related works:
Journal Article: Optimal transaction filters under transitory trading opportunities: Theory and empirical illustration (2010)
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