How profitable are FX technical trading rules?

This paper provides a comprehensive empirical investigation of the profitability of foreign exchange technical trading rules over the 1996:10–2015:06 period for 22 currencies quoted in US dollars. It reports evidence of profitability across a universe of 113,148 rules that include traditional moving average rules and those constructed on the basis of technical indicators such as Bollinger bands and the relative strength index. The best trading rules achieve annualised returns of up to 30%. The Step-SPA test (Hsu, Hsu, & Kuan, 2010) results show a sharp fall in the total number of rules that are robust to data snooping bias. Virtually no traditional rule is significant in the 2006–2015 sub-sample, in line with the adaptive market hypothesis. By contrast, rules based on new technical indicator such as Bollinger band and relative strength index rules remain robustly profitable across all currencies over the more recent sub-sample.     

Can technical trading beat the foreign exchange market in times of crisis?

I examine the profitability of three simple foreign exchange technical trading rules (moving average, momentum, and relative strength index) before, during, and after the 2007–2008 global financial crisis. These rules significantly improve profitability during the crisis (as opposed to before and after it). The moving average rule significantly increases profitability for exchange rate changes during the crisis. The momentum and relative strength index rules generate significant positive excess currency returns (defined as the difference between the forward premium and spot rate changes), but this profitability is not visible in spot rate changes. These findings are robust for portfolios of developed and emerging market currencies as well as for bilateral exchange rates.     

Is trading in the shortest-term index options profitable?

Review of Derivatives Research - The aim of this study is to examine the return rates of the TAIEX options with at most 8 calendar days to maturity using a buy-and-hold strategy. Although our...     

Does intraday technical analysis in the U.S. equity market have value?

This paper investigates whether intraday technical analysis is profitable in the U.S. equity market. Surveys of market participants indicate that they place more emphasis on technical analysis (and less on fundamental analysis) the shorter the time horizon; however, the technical analysis literature to date has focused on long-term technical trading rules. We find, using two bootstrap methodologies, that none of the 7846 popular technical trading rules we test are profitable after data snooping bias is taken into account. There is no evidence that the market is inefficient over this time horizon.     

Does information drive trading in option strategies?

We study trading in option strategies in the FTSE-100 index market. Trades in option strategies represent around 37% of the total number of trades and over 75% of the total trading volume in our sample. We find some evidence that order flow in volatility–sensitive option strategies contains information about future realized volatility. We do not find evidence that order flow in directionally–sensitive option strategies contains information about future returns. Overall, our evidence suggests that option strategies are used both by traders who possess non-public information about future volatility and by uninformed speculators who appear to follow unprofitable trend chasing strategies.     

Does informed trading occur in the options market? Some revealing clues

This paper analyses the relationship between proxy variables for informed trading in the options market and a set of exogenous news variables. The aim was to test directly for the presence or absence of informed trading in the options market and for the possible impact of this trading on underlying asset prices. Our findings reveal that potential informed trading in options markets is channelled basically through out‐of‐the‐money options, except for volatility trading which mainly involves at‐the‐money options because of their liquidity. In both cases, we have found evidence in favour of investors’ strategic fragmentation of transactions into intermediate size trades (stealth trading). Finally, it is shown that lack of consensus among agents also generates increased trading, particularly in out‐of‐the‐money and at‐the‐money options.     

Are tightened trading rules always bad? Evidence from the Chinese index futures market

This paper investigates the impact of tightened trading rules on the market efficiency and price discovery function of the Chinese stock index futures in 2015. The market efficiency and the price discovery of Chinese stock index futures do not deteriorate after these rule changes. Using variance ratio and spectral shape tests, we find that the Chinese index futures market becomes even more efficient after the tightened rules came into effect. Furthermore, by employing Schwarz and Szakmary [J. Futures Markets, 1994, 14(2), 147–167] and Hasbrouck [J. Finance, 1995, 50(4), 1175–1199] price discovery measures, we find that the price discovery function, to some extent, becomes better. This finding is consistent with Stein [J. Finance, 2009, 64(4), 1517–1548], who documents that regulations on leverage can be helpful in a bad market state, and Zhu [Rev. Financ. Stud., 2014, 27(3), 747–789.], who finds that price discovery can be improved with reduced liquidity. It also suggests that the new rules may effectively regulate the manipulation behaviour of the Chinese stock index futures market during a bad market state, and then positively affect its market efficiency and price discovery function.     

Are investors consistent in their trading strategies? An examination of individual investor-level data

While it has been demonstrated that momentum or contrarian trading strategies can be profitable in a range of institutional settings, less evidence is available concerning the actual trading strategies investors adopt. Standard definitions of momentum or contrarian trading strategies imply that a given investor applies the same strategy to both their buy and sell trades, which need not be the case. Using investor-level, transaction-based data from China, where tax effects are neutral, we examine investors' buy-sell decisions separately to investigate how past returns impact differentially on the trading strategies investors adopt when buying and selling stock. After controlling for a wide range of stock characteristics, extreme price changes and portfolio value, a clear asymmetry in trading is observed; with investors displaying momentum behavior when buying stocks, but contrarian behavior when selling stocks. This asymmetry in behavior is not driven purely by reactions to stock characteristics or extreme stocks. We discuss behavioral and cultural explanations for our findings.     

Fluctuations in the UK equity market: what drives stock returns?

Present value parameters from a state-space model are estimated for the UK FT All-Share Index. The estimated parameters are used to construct a time series of expected future returns and expected future values of dividend growth, both of which are found to be time-varying with persistent components. Variations in the price-dividend ratio appear to be driven primarily by the variance in expected returns. A comparison with the findings from a present value-constrained vector autoregression model indicates that the latter forecasts future realized returns and dividend growth better than the series constructed using a state-space approach. Furthermore, when the model is estimated for monthly and quarterly data, expected dividend growth is found to be more persistent.     

Are regime-shift sources of risk priced in the market?

In this paper we develop a discrete-time pricing model for European options where the log-return of the underlying asset is subject to discontinuous regime shifts in its mean and/or volatility which follow a Markov chain. The model allows for multiple regime shifts whose risk cannot be hedge out and thus must be priced in option market. The paper provides estimates of the price of regime-shift risk coefficients based on a joint estimation procedure of the Markov regime-switching process of the underlying stock and the suggested option pricing model. The results of the paper indicate that bull-to-bear and bear-to-crash regime shifts carry substantial prices of risk. Risk averse investors in the markets price these regime shifts by assigning higher transition (switching) probabilities to them under the risk neutral probability measure than under the physical. Ignoring these sources of risk will lead to substantial option pricing errors. In addition, the paper shows that investors also price reverse regime shifts, like the crash-to-bear and bear-to-bull ones, by assigning smaller transition probabilities under the risk neutral measure than the physical. Finally, the paper evaluates the pricing performance of the model and indicates that it can be successfully employed, in practice, to price European options.     

Are capital controls in the foreign exchange market effective?

One of the reasons for governments to employ capital controls is to obtain some degree of monetary independence. In this paper we test whether capital controls can reduce the link between exchange rates fluctuations and cross border interest differentials. Recent capital control proxies are used in order to determine the date of capital account liberalization for a panel of Western European and emerging countries. Results show that capital controls have a very limited effect on observed deviations from interest parities, even when accounting for the political risk associated with capital controls.     

Did CDS trading improve the market for corporate bonds?

Financial innovation through the creation of new markets and securities impacts related markets as well, changing their efficiency, quality (pricing error), and liquidity. The credit default swap (CDS) market was undoubtedly one of the salient new markets of the past decade. In this paper we examine whether the advent of CDS trading was beneficial to the underlying secondary market for corporate bonds. We employ econometric specifications that account for information across CDS, bond, equity, and volatility markets. We also develop a novel methodology to utilize all observations in our data set even when continuous daily trading is not evidenced, because bonds trade much less frequently than equities. Using an extensive sample of CDS and bond trades over 2002–2008, we find that the advent of CDS was largely detrimental. Bond markets became less efficient, evidenced no reduction in pricing errors, and experienced no improvement in liquidity. These findings are robust to various slices of the data set and specifications of our tests.     

Do momentum-based trading strategies work in emerging currency markets?

We appear to be the first to present correctly calculated results for the profitability of emerging currency momentum strategies using a long time series and a good cross-sectional sample. Using a 1985–2009 sample period and six emerging currencies, we find that long-short momentum strategies gained about 1–3% per annum after actual transaction costs. These profits declined through time (both economically and statistically), however, with most of our strategies losing money after transaction costs during the last five years of our sample. These results are similar to, though slightly more volatile in the cross section, than those published for major currencies.     

Are there arbitrage gaps in the UK gilt strips market?

Evidence in financial markets of an opportunity for pure arbitrage, and therefore a violation of the law of one price, is considered an anomaly to be noted. This paper reports an apparent violation of the law of one price between UK government gilts and their separately traded principal and coupon strips over a sample period of nearly 14 years. There are persistent price differences, and hence opportunities for arbitrage, after allowance for the bid-ask spread; the strips package tends to be overpriced in relation to the corresponding gilt. The price differences may, in part, be due to a lack of liquidity and stale prices in the strips market.     

Are idiosyncratic volatility and MAX priced in the Canadian market?

The negative relationship between realized idiosyncratic volatility (RIvol) and future returns uncovered by Ang et al. (2006) for the U.S. market has been attributed to return reversals. For the Canadian market where return reversals are considerably less important, we find that RIvol is positively related to future returns, even after controlling for risk loadings, illiquidity and reversals. Unlike the findings of Bali et al. (2001) for the U.S. market, we find that the relationship between extreme positive returns (MAX) and future returns for the Canadian market is positive and that idiosyncratic volatility continues to be consistently positively related to future returns after controlling for MAX. We find evidence that suggests that reversals for stocks with extreme daily returns are confined to (typically small) stocks with low institutional holdings.     

Are extreme returns priced in the stock market? European evidence

This paper revisits some recently found evidence in the literature on the cross-section of stock returns for a carefully constructed dataset of euro area stocks. First, we confirm recent results for US data and find evidence of a negative cross-sectional relation between extreme positive returns and average returns after controlling for characteristics such as momentum, book-to-market, size, liquidity and short term return reversal. We argue that this is the case because these stocks have lottery-like characteristics, which is attractive to certain investors. Also, these stocks tend to be very volatile so that arbitrageurs are discouraged from correcting potential mispricing. As a consequence, these stocks are often overpriced and hence face lower expected returns. Second, when we control for extreme returns, the recently found negative relationship between idiosyncratic risk and future returns is less robust. In our models, after adding maximum returns, the relationship is insignificant and sometimes even positive. We also find that idiosyncratic skewness and coskewness play an important role for asset pricing, as predicted by several theoretical models.     

Does the equity premium puzzle persist during financial crisis? The case of the French equity market

This paper examines the effects of the financial crisis that began in 2008 on the equity premium of 6 French sector indices. Since the systematic risk coefficient beta remains the most common explanatory element of risk premium in most asset pricing models, we investigate the impact of the crisis on the time-varying beta of the six sector indices cited. We selected daily data from January 2003 to December 2012 and we applied the bivariate MA-GARCH model (BEKK) to estimate time-varying betas for the sector indices. The crisis was marked by increased volatility of the sector indices and the market. This rise in volatility led to an increase in the systematic risk coefficient during the crisis and first post-crisis period for all the major indices. The results are intuitive and corroborate findings in the empirical literature. The increase of the time-varying beta is considered by investors as an additional risk. Therefore, as expected, investors tend to increase their equity premiums to b ear the impact of financial crisis.     

Does insider trading have information content for the bond market?

This study documents that there is significant information content in stock trading by registered corporate insiders for the bond market. We report significant positive price reactions for convertible and straight bonds in response to the Wall Street Journal's Insider Trading Spotlight publication of insider buy transactions and significant negative reactions for insider sell transactions. The stock market response to the publication of the insider transactions, although weaker than the bond market reaction, is also found to be significant. Cross-sectional results suggest that bond market participants extract the quality of the insider-trading signal by observing factors such as the dollar volume of the trade, the percentage change in the holding of the insider, and the insider's position in the firm. Lower-rated (riskier) bonds are found to be more sensitive to the information than higher-rated issues. The empirical evidence presented in this paper suggests that the absence of any reporting requirement for insider bond transactions may create aan enhanced opportunity for the insiders to exploit private information to expropriate wealth from uninformed bond traders.     

Have capital market anomalies attenuated in the recent era of high liquidity and trading activity?

We examine whether the recent regime of increased liquidity and trading activity is associated with attenuation of prominent equity return anomalies due to increased arbitrage. We find that the majority of the anomalies have attenuated and the average returns from a portfolio strategy based on prominent anomalies have approximately halved after decimalization. We provide evidence that hedge fund assets under management, short interest and aggregate share turnover have led to the decline in anomaly-based trading strategy profits in recent years. Overall, our work indicates that policies to stimulate liquidity and ameliorate trading costs improve capital market efficiency.     

Can Warren Buffett forecast equity market corrections?

Warren Buffett suggested that the ratio of the market value of all publicly traded stocks to the Gross National Product could identify potential overvaluations and undervaluations in the US equity market when this ratio deviates above 120% or below 80%. We investigate whether this ratio is a statistically significant predictor of equity market corrections and rallies. We find that Buffett's decision rule does not deliver satisfactory forecasts. However, when we adopt a time-varying decision rule, the ratio becomes a statistically significant predictor of equity market corrections. The two time-varying decision rules are: (i) predict an equity market correction when the ratio exceeds a 95% one-tail confidence interval based on a normal distribution, and (ii) predict an equity market correction when the ratio exceeds a threshold computed using Cantelli's inequality. These new decision rules are robust to changes in the two key parameters: the confidence level and the forecasting horizon. This paper also shows that the MV/GNP ratio performs relatively well against the four most popular equity market correction models, but the ratio is not a particularly useful predictor of equity market rallies.