Can risk explain the profitability of technical trading in currency markets?

RePEc Short ID: pne3
ORCID iD: 0000-0003-2852-9419

Famiglietti, Matthew; Ivanova, Yuliya; Neely, Christopher J.; Weller, Paul A.

doi:10.20955/wp.2014.033

Working Paper Revision

Can risk explain the profitability of technical trading in currency markets?

Abstract: Academic studies show that technical trading rules would have earned substantial excess returns over long periods in foreign exchange markets. However, the approach to risk adjustment has typically been rather cursory. We examine the ability of a wide range of models: CAPM, quadratic CAPM, downside risk CAPM, Carhart’s 4-factor model, the C-CAPM, an extended C-CAPM with durable consumption, Lustig-Verdelhan (LV) carry-trade factor model, and models including macroeconomic factors, and foreign exchange volatility, skewness and liquidity, to explain these technical trading returns. No model plausibly accounts for much of the technical profitability. This failure implicitly supports non-risk based explanations such as adaptive markets.

Keywords: Exchange rate; Technical analysis; Technical trading; Efficient markets hypothesis; Risk; Stochastic Discount Factor; Adaptive markets hypothesis; Carry trade;

JEL Classification: F31; G11; G12; G14;

https://doi.org/10.20955/wp.2014.033

Status: Published in Journal of International Money and Finance