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Table of Contents
CHAPTER 1 3
INTRODUCTION 3
CHAPTER 2 6
LITERATURE REVIEW 6
2.1. The efficient market hypothesis 6
2.2. Literature of the wild bootstrapping variance ratio test 7
2.3. Literature of technical trading rules testing 9
CHAPTER 3 11
FOREIGN EXCHANGE MARKET, TECHNICAL TRADING RULES AND THE
METHODOLOGIES OF TESTING 11
3.1. Foreign exchange market mechanism and features 11
3.2. Technical trading rules 12
3.3. Methodologies of testing 15
3.3.1. Variance Ratio test with Bootstrap methodology 15
3.3.2. Technical trading rules testing 17
CHAPTER 4 22
DATA 22
CHAPTER 5 25
EMPIRICAL RESULTS 25
5.1. Wild bootstrapping Variance ratio test 25
5.2. Traditional statistics of trading rules 27
CHAPTER 6 39
IMPLICATION AND EXPLANATION 39
CHAPTER 7 43
CONCLUSION 43
ACKNOWLEDGEMENTS 44
REFERENCES 45
APENDIX 1 49
2
Dissertation of MSc International
Money and Banking 2011-2012
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY
MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
THANH THUY HOANG
Abstract:
This dissertation investigates the efficiency of five major currency markets which are
USD/JPY, USD/CHF, USD/AUD, USD/EUR, and GBP/USD. In this study, the market
efficiency hypothesis is examined by a wild bootstrapping variance ratio test and the
technical trading rules. According to the wild bootstrapping variance ratio test,
USD/AUD and USD/EUR follow the random walk process while the others do not. In
general, the results from testing the moving average rules and trading range
breakout rules support for the variance ratio test results, except for Australian Dollar
case. In more details, there are some evidences of the predictive power of technical
trading rules in the exchange rates which are confirmed that they do not follow
random walk by the variance ratio test.
Keywords: Market efficiency hypothesis, Exchange rates, Variance ratio test,
Bootstrap, Technical trading rules, Dummy variables.
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
3
CHAPTER 1
INTRODUCTION
The foreign exchange (FX) market has a long history of development; especially it
has developed dramatically since the era of high technology revolution. With high-
speed Internet connection and supercomputers, a very large proportion of trade now
can be done electronically, automatically and the FX market becomes the most liquid
financial market in the world. Consequently, it attracts an enormous amount of
speculators who want to get a profit from the market. As the number of market
participants in FX market continues to increase, a debate about FX market efficiency
has been raised. Is it possible to enjoy excess returns on FX market just based on
historical trading data and automatic trading rules? Or is the market simply
unpredictable and no speculators can beat the market? There are two principal
schools of thought about this issue. The first school supposes that the FX market
follows the efficient market hypothesis (EMH), so exchange rates follows random
walk and it is impossible to earn abnormal returns on this market. By contrast,
advocates of the second school do not believe in EMH and there are some technical
trading rules can be utilized to make excess profit. In order to test this hypothesis,
random walk test and technical trading rules can be considered as the popular and
favourite proxies. Indeed, these proxies were used to examine EMH by Lee et.al
(2001), Tabak and Lima (2009).
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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About the first proxy, if an exchange rate follows a random walk process, that FX
market can be considered as following the weak form of market efficiency and that
exchange rate cannot be predicted. There are many tools to test the random walk
hypothesis, however the variance ratio test is judged as the most powerful one
because of its advantages. This methodology is well known and used widely. For
example, Charles and Darne (2009) tested the random walk behaviour of exchange
rate of Euro against US dollar by a variance ratio test. However, in this dissertation,
the variance ratio test will be improved by combining with the bootstrap methodology
to test the random walk hypothesis.
Another way to test the predictability of the foreign exchange market is examining
the profitability of technical trading rules. According to Brock et.al (1992), technical
analysis has been used from 19
th
century and become well-known now. Although it
was originally developed in the stock market, technical analysis then has been
employed broadly in other markets such as gold, commodity or foreign exchange. It
is obvious that if trading rules can generate excess returns, it implies that exchange
rates can be forecasted and the market is inefficient. This dissertation explores two
simplest and the most popular technical rules in the foreign exchange market, which
are moving average strategy and trading break range. There were several papers
which investigated about the application of these rules in foreign exchange trading
and whether they make a profit or not. Some of them (Lee et.al (2001), Neely and
Weller (2003)) said that the technical trading rules are useless, however; others
(Neely et.al (1997), LeBaron (1999), Saacke (2002)) pointed out some evidences of
excess returns to technical trading rules in foreign exchange market.
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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It is apparent that variance ratio test, bootstrapping and the profitability of trading are
not new topics to finance literature. The initial contribution of this dissertation is,
however, using these techniques to investigate the profitability of trading rules in the
context of market efficiency hypothesis with updated data of the selected currency
pairs. Firstly, this dissertation applies bootstrap techniques into variance ratio test to
research the randomness of exchange rates. Secondly, my study uses t- test in
order to examine the significance of abnormal returns from trading rules. Moreover,
utilizing update data of five currency pairs (USD/JPY, USD/CHF, USD/AUD,
USD/EUR, GBP/USD) would help to revise the profitability of trading rules in a big
picture of the FX market and compare the application of trading rules in a pool of the
researched currency pairs. Some concepts in this dissertation are influenced by
Brock et.al (1992) and Lee et.al (2001) but my studied objects are different. Another
striking contribution of this study is providing some suggestions which based on
practical experiences, for why some currency pairs follow random walk and others
do not.
This study reveals that the results from wild bootstrapping variance ratio test are
generally consistent with the test of trading rules profitability. The variance ratio tests
suggest that USD/CHF, GBP/USD, USD/JPY do not follow the random walk process.
Indeed, there are some evidences of excess returns from trading these exchange
rates by examined trading rules. By contrast, in accordance with the variance ratio
tests, USD/AUD and USD/EUR follow random walk, which means that there is
impossible to earn abnormal returns from these currency pairs. Another remarkable
result is that, according to t- test statistics, there is little evidence of trading rules
profitability with USD/AUD data.
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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The structure of this dissertation is organised as follows: Literature of the wild
bootstrapping variance ratio test and technical analysis will be discussed in Chapter
2. Chapter 3 describes the foreign exchange market, technical trading rules and
testing methodology. The data will be explained clearly in the Chapter 4. Chapter 5
assesses the significance of results from the wild bootstrapping variance ratio test
and traditional statistics. Chapter 6 expresses the implication and explanation of
results. Finally, the conclusion is drawn in Chapter 7.
CHAPTER 2
LITERATURE REVIEW
2.1. The efficient market hypothesis
The efficient market hypothesis (EMH) states that a market is efficient when all
available information in the market is fully reflected into prices (exchange rates).
According to Fama (1970), there are three forms of market efficiency which are the
strong, the semi-strong and the weak form hypothesis (the return predictability
hypothesis by Fama (1991)). Among these forms, the weak- form EMH which
indicates a random walk is the most commonly examined topic in the empirical
literature.
If an exchange rate follows a random walk process, it means the market is the weak
form of the EMH. In this case, the exchange rate cannot be forecasted, so it is
impossible for speculators to earn abnormal returns. By contrast, if the null
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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hypothesis of random walk is rejected, the exchange rate is predictable and excess
returns could be generated using specific investment strategies.
2.2. Literature of the wild bootstrapping variance ratio test
Based on the above concept, there are enormous numbers of papers which
investigated the randomness of exchange rates. Lee et.al (2001) stated that the
variance ratio test is considered to be more powerful than other methods, such as
unit root tests and BoxPierce Q test for serial correlations. In more details, Lee et.al
(2001) argued that the hypothesis of unit root only refers to the zero-mean
stationary process of the error, so an exchange rate which has a unit root can still
be forecasted, ultimately leading to the wrong conclusion of randomness. In fact, the
conventional form of variance ratio test was introduced first by Lo and MacKinlay
(1988). Applying this methodology, Liu and He (1991) found that five examined
currency pairs (CAD, JPY, GBP, FF and DM relatives to USD) reject the random
walk hypothesis at 5% significance level. With the set of Asian data, Ajayi and
Karemera (1996) indicated that the Malaysian ringgit, the Taiwanese dollar and the
Thai baht do not follow the EMH, whereas the rest five pairs (Hong Kong dollar,
Indonesia rupiah, Singaporean dollar, Korean won, Philippine peso) follow the
random walk process. The multiple variance ratio test then was developed by Chow
and Denning (1993). However, These VR tests are asymptotic tests, which can
show small sample deficiencies, stated by Kim (2006, p.1). Therefore, Kim (2006)
suggested the wild bootstrapping methodology to increase small sample properties
of these tests.
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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It is necessary to review the literature of this bootstrap method. Bootstrapping is
considered as a procedure to measure the accuracy of an estimator by Ruiz and
Pascual (2002, p4). The outstanding benefit of bootstrapping is that it does not
require any special assumption of the distribution of researched data. Another
advantage of this methodology is that it is very simple to use independently of the
complexity of statistics interest. Therefore, bootstrap is applied broadly to null
models such as GARCH models, Value at risk (VaR), Variance ratio test, to name
just a few. For example, Brock (1992) applied bootstrap methodology to generate
distribution of statistics under four null models which are a random walk with a drift,
AR(1), GARCH-M, EGARCH in order to test the trading rules profitability in the US
stock market. Bootstrap technique was also utilized by LeBaron (1999) in examining
the profitability of trading rules as central bank intervention.
Combining the bootstrap methodology with the Variance ratio test helps to check the
random walk hypothesis without the necessity of normality and homoscedasticity.
Therefore, there are many empirical studies which used both these methodologies.
Indeed, by applying Lo and MacKinlay (1988) test and resampling technique of
bootstrap, Chang (2004) concluded that the Japanese Yen reject the random walk
hypothesis while the Canadian dollar, the French Franc, the German mark and the
British pound are inclusive. In a different way, Lee et.al (2001) used multiple
variance ratio tests of Cecchetti and Lam (1994) with bootstrap technique to test
EMH in nine currency pairs. From their conclusion, only the Korean won does not
reject the null hypothesis while the rest does. By mixing Lo and MacKlay VR (1988),
Cecchetti and Lam VR (1994) and bootstrapping, Lima and Tabak (2007) found
evidences of the randomness in 10 selected currency pairs.
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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It can be said that there are several ways to combine the variance ration test and the
bootstrapping technique. Kim (2006) proposed one of that, which is a wild
bootstrapping variance ratio test. According to Kim (2006, p.39), It is a resampling
method that approximates the sampling distribution of a statistic, and is applicable to
data with unknown forms of conditional and unconditional heteroskedasticity. This
combination of these methodologies becomes famous and is introduced to the
econometrics software as Eviews 7. This dissertation applied this method of Kim
(2006) and found there are evidences of random walk in USD/AUD and USD/EUR
data. The finding about the Australian Dollar is consistent with the recent results from
Lee et.al (2001) and Azad (2009). Accordingly, the randomness of USD/EUR
confirms the conclusion of Chen (2008).
2.3. Literature of technical trading rules testing
As stated above, testing profitability of technical trading rules can be considered as
another way to test the efficient market hypothesis. According to Murphy (1986) and
Pring (1991), technical analysis is based on three following principles. Firstly, prices
and volume in the market incorporate related information, so it is not necessary to
analyse fundamentals. Secondly, there are trends in the price movements. Thirdly,
history tends to repeats itself. Technical analysis method can be categorized into
two main schools: charts and indicators. The effectiveness of using technical
indicators in trading foreign currencies is still a controversial topic and it is mentioned
in numerous previous papers. Regarding to stock markets, Brock et.al (1992)
researched the moving average rules and trading range break out rules which are
the simplest and most popular by utilizing the Dow Jones index. In this paper, Brock
et.al (1992) tested in two cases which are trading rules with 1% band and without
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
10
band. The test results reported that there are several evidences of excess returns by
using these rules. However, when Hudson et.al (1996) repeated similar tests with the
UK stock market, the results found that although trading rules can predict the
movement of stock prices, it is impossible to earn abnormal returns in the presence
of costly trading. Hudson et.al (1996) also studied the relationship between technical
trading rules and the weak form of market efficiency.
For foreign exchange market, Lee and Mathur (1996) applied bootstrap methodology
in and out of sample tests to study the profitability of moving average trading rules
with six European spot cross rates data. They found that the moving average trading
rules only makes positive profits in case of JY/DM and JY/SF, whereas, in case of
other exchange rates, the profitability of these rules is not significant. From a
different perspective, LeBaron (1999) investigated trading rules profitability in the
context of central bank intervention in the United States. In particular, LeBaron
(1999) applied bootstrap methodology into testing whether moving average rules can
produce abnormal returns. The test results indicated that the simple moving average
rules can forecast movements in USD/JPY and USD/DM pairs noticeably.
Nevertheless, LeBraron (1999) findings also concluded that the forecast ability of the
trading rule declines significantly if the Feds intervention period was excluded.
Among previous studies, there are several papers which combine two above proxies
in order to test the random walk hypothesis. Lee et.al (2001) applied joint variance
ratio test and technical trading rules (moving average and channel) to test whether
nine Asian exchange rates follow the random walk process or not. Eight over nine
currency pairs rejected the null hypothesis at 5% significant level, which implies little
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
11
evidence of randomness of these exchange rates. The test results concluded that
these rules do not bring significant excess returns.
By replicating the methodologies, the study of Tabak and Lima (2009) employed
Brazilian exchange rate data to test the weak form efficiency. The variance ratio
tests of this work are used in combination with block bootstrap methodology to
prevent size distortions. Their first finding is that there are evidences of random walk
in the short run, but the null hypothesis is rejected in the long run. The second
conclusion is that the trading rules Moving average rules and Trading range
breakout rules- are not significant in generating abnormal returns.
CHAPTER 3
FOREIGN EXCHANGE MARKET, TECHNICAL TRADING RULES
AND THE METHODOLOGIES OF TESTING
3.1. Foreign exchange market mechanism and features
Foreign exchange market is considered as the largest and the most liquid market on
the world with more than $4 trillion average daily trading volume (Bank for
International Settlement, 2010). In this market, goods are not exchanged for money;
goods are indeed currencies - the monetary units. Indeed, the FX market is not a
physical place; it is mainly an electronic linking system among big banks, large
financial companies, brokers, dealers and so on. It can be said that this is the most
liquid market in comparison with others markets.
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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In the scope of this dissertation, there are two main concepts in this market which
should be considered. Firstly, the exchange rate is described as the price of foreign
currency denominated in domestic currency. Exchange rates can be expressed by
quoting the amount of domestic currency against U.S.Dollar (the most common way)
or vice-versa, for example GBP/USD. Secondly, bid and offer rate are often quoted
by two numbers which are bid (buys mark) and offer (sells mark) for example:
GBP/USD= 1.5675/85. Spread is the difference between two prices and it is often
very small. In order to calculate returns easily, this dissertation will ignore the spread
and use the middle rate instead of bid and offer rate.
Due to the wide availability of leverage using (up to 1:100), foreign exchange market
offers high potential profit, people always try to analysis in order to find any chance
of making money. There are two schools of analysing this market which are
fundamental analysis and technical analysis. The fundamental analysis refers to
economic growth, inflation, interest rate, monetary and fiscal policies, balance of
payment and so on. By contrast, the technical analysis refers to trading volume,
chart, price movement and theories.
3.2. Technical trading rules
Technical analysis originated with the simple form from the late of 1800s with the
work of Charles Dow. According to Edwards et.al (2007)- Bassetti 9
th
ed, technical
analysis can be considered as the study of the action of the market itself. Indeed, it
utilizes the historical data of the exchange rates and summarizes in graphic forms in
order to deduce the movement of exchange rates in the past then forecast the
exchange rates in the future. As the main concept of technical analysis is that the
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
13
history repeats itself, technical analysis tend to studies the market background and
habits, consequently it includes a great variety of rules which represent for various
forms and trends of the exchange rate movement.
Two simplest rules can be listed as the moving average- oscillator and the trading
range break-out. The moving average strategy is a simple but popular and useful
tool, and another advantage of the moving averages is that it makes the volatile
series smoother. Along with the development of computers, there are various forms
of the moving averages which can categorized as Simple Moving Averages (SMA),
Weighted or Exponential Moving Averages (EMA), and Linear Moving Averages
(LMA). This study, however, just concentrates the simple-but-useful SMA, in which
buy and sell signals are generated when two moving averages of the exchange rates
cross each other. In more details, buy signals are created since the short- period
moving averages cross the long- period moving averages from below. By contrast,
sell signals are generated when the short - period moving averages cross the long-
period moving averages from above. The length of the period of moving averages
could be various, however the most popular length are 50 and 200 days. In order to
improve the sensitivity of moving averages, this dissertation will examine additionally
10 and 20 days moving averages. The way of building up these moving averages is
the same with every moving average. For instance, 10 days moving average (MA-
10) is equal to the sum of the exchange rate of 10 days divided by 10. Repeating the
same procedure will create MA-50, MA-100 and MA-200. The moving average
strategy can lead to different decisions if band is introduced or not. In other words,
introducing band to moving average rules can bring various signals. Thus, this
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
14
dissertation will investigate both the moving average with band and without band
(1% band).
With the simple moving average strategy, this study will analyse thoroughly two
specific types which are the variable length moving average (VMA) and the fix length
moving average. Firstly, the variable length moving average is the rule in which buy
signals are generated when the short moving average penetrates the long moving
average on the upside; while sell signals are created as the short moving average
falls below the moving average line. Without band or a band of zero, the traders can
either buy or sell. By contrast, with a band, if the short moving average line is inside
the band, no signal is generated and trading signals would only are generated when
the short moving average is out of the band.
Secondly, the fix length moving average indicates that buy (sell) signals will be
generated when the short moving average line goes above (below) the long moving
average, then that position will be hold for x days. In next x days, any signals
generated will be ignored. Return of x days holding will be recorded to examine. This
study will investigate the fix length moving average with ten days returns. It should
be noted that there are several forms of moving average rules and this dissertation
just researches two simple types among them.
The final rule which is tested in this dissertation is the trading range break out
(resistance and support levels). In technical analysis, resistance and support level
are the concepts related to the local maximum and minimum respectively. Because
traders believe that others will sell when the exchange rate reaches the peak, and
sell when the exchange rate goes to the bottom, it will create the resistance (support)
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
15
levels where the exchange rate will fall (increase) again. However, in case the
exchange rate does not fall, continues to increase and break the resistance level, it
is the buy signal. By contrast, if the exchange rate fall below the support level, sell
signal is generated. With trading range break rule, this study will also introduce band
to investigate the effect of band on the trading rules. Trading range strategy
researches 50, 150 and 200 days maximum (minimum).
3.3. Methodologies of testing
3.3.1. Variance Ratio test with Bootstrap methodology
For testing random walk hypothesis, this study utilized the variance ratio (VR) test
which was developed Lo and MacKinlay (1988) and then became popular tool in
random walk testing. This test helps to examine the predictability of exchange rates
by comparing variances of differences of the data gauged over various intervals. The
main concept of this test is that the variance of the random walk increments must be
linear function of the time intervals. In more details, if the exchange rate follows a
random walk, the variance of the
Where
difference of the
exchange rate and
Where
MA(n) is the moving average in n days
S
t
is the exchange rate in date t
It should be noted that the data which is used to test is not exchange rate, is return
of trading rules. Therefore, it is necessary to indicate buy (sell) signals then calculate
return with respect to those signals. In order to indicate buy (sell) signals with
variable moving average (VMA), this study utilized dummy variables- D with values
as following:
Case: Band of zero
D
t
= +1 if S
t
> MA(n) or MA(n
1
) > MA(n
2
)
-1 if S
t
< MA(n) or MA(n
1
) < MA(n
2
)
D
t-1
if S
t
= MA(n) or MA(n
1
)=MA(n
2
)
Case: Band of 1%
D
t
= +1 if S
t
>1.01 x MA(n) or MA(n
1
) > 1.01x MA(n
2
)
-1 if S
t
< 0.99 x MA(n) or MA(n
1
) <0.99 x MA(n
2
)
0 if 0.99 x MA (n) <=S
t
<= 1.01 x MA(n)
or 0.99 x MA (n
2
) <=MA (n
1
) <= 1.01 x MA(n
2
)
Where
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
19
D
t
is dummy variable of VMA at date t
MA(n
1
) is the short moving average in n
1
days and MA(n
2
) is the long moving
average in n
2
days with n
1
<n
2
.
According to the simple moving average rule indicated above, dummy variable (D)
equals to +1 is buy signal, D
t
equals to -1 is sell signal and 0 is no signal. Returns
from the trading in accordance with above signal are gauged as below
R
t
= D
t
x (ln (S
t+1
)- ln (S
t
) 1/260 (i
t
i
t
*))
Where
R
t
: Return of date t
D
t
: Dummy variable of VMA at date t
S
t+1
: Exchange rate at date t
S
t
: Exchange rate at date t
i
t
: annual interest rate of domestic currency at date t
i
t
*: annual interest rate of foreign currency at date t
In this study, it is assumed that there are 260 trading days per year (5 days per
weeks and 52 weeks per year), so it would be more precise if calculate interest rate
of holding currency per day is equal to annual interest rate divided by 260 (not 365).
This function was used to test technical analysis on USD/DEM pair by Saacke
(2002).
The way of defining dummy variable with the fix length moving average (FMA) is little
bit different because this rule indicates that after the buy (sell) signal is generated,
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
20
other signals within 10 days are ignored. Dummy variable and 10days returns of
FMA are explained as below:
D
t
= D
t
if average of D
t
within 10 days is equal to 0
0 if average of D
t
within 10 days is not equal to 0
R_10
t
= D
t
x (ln (S
t+10
)- ln (S
t
) 10/260 (i
t
i
t
*))
Where:
D
t
is the dummy variable of FMA at date t
D
t
is the dummy variable of VMA at date t
S
t+10
is the exchange rate at date t+10
S
t
is the exchange rate at date t
i
t
: annual interest rate of domestic currency at date t
i
t
*: annual interest rate of foreign currency at date t
Secondly, with trading range break out (TRB), buy (sell) signals and returns are
defined as follow:
D
t
= +1 if S
t
> Max ( S
t
, S
t+1
, , S
t+1
)
-1 if S
t
< Min (S
t
, S
t+1
, , S
t+1
)
0 if Min (S
t
, S
t+1
, , S
t+1
) < S
t
< Max (S
t
, S
t+1
, , S
t+1
)
R
t
= D
t
x (ln (S
t+1
)- ln (S
t
) 1/260 (i
t
i
t
*))
Let denote D
t
is the dummy variable of TRB at date t.
TESTING EFFICIENCY OF FIVE MAJOR CURRENCY MARKETS BY A WILD BOOTSTRAPPING VARIANCE
RATIO TEST AND TECHNICAL TRADING RULES
MSc International Money and Banking
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Thirdly, t- statistics for buy (sell) signal are gauged as the function which Brock et.al
(1992) used
t- value Buy (Sell) =
Where
is respectively the mean return and the number of buy or sell signals
, is respectively the unconditional mean return and the number of observations.
Where