Financial Returns and E ¢ ciency as seen by an Arti cial Technical Analyst ¤

We introduce trading rules which are selected by an arti…cially intelligent agent who learns from experience an Arti…cial Technical Analyst. It is shown that these rules can lead to the recognition of subtle regularities in return processes whilst reducing data-mining problems inherent in simple rules proposed as model evaluation devices. The relationship between the e¢ciency of …nancial markets and the e¢cacy of technical analysis is investigated and it is shown that the Arti…cial Technical Analyst can be used to provide a quanti…able measure of market e¢ciency. The measure is applied to the DJIA daily index from 1962 to 1986 and implications for the behaviour of traditional agents are derived. ¤The research leading to this paper was supported by a grant from I.K.Y.. Thanks are due to Buz Brock, Dave Cass, Alex Gumbel, Blake LeBaron, Mark Salmon and particularly Ramon Marimon for useful comments and suggestions on previous versions of this paper. Blake LeBaron is also thanked for providing the necessary data.

[1]  Bong-Chan Kho.  Time-varying risk premia, volatility, and technical trading rule profits: Evidence from foreign currency futures markets , 1996 .

[2]  R. Gencay.  Non-linear prediction of security returns with moving average rules , 1996 .

[3]  Myron S. Scholes,et al.  Estimating betas from nonsynchronous data , 1977 .

[4]  Salih N Neftci,et al.  Naive Trading Rules in Financial Markets and Wiener-Kolmogorov Prediction Theory: A Study of "Technical Analysis." , 1991 .

[5]  S. Domenico.  Risk Neutral Forecasting , 1998 .

[6]  P. M. Allen,et al.  Evolution, Creativity and Intelligence in Complex Systems , 1993 .

[7]  Blake LeBaron,et al.  An Evolutionary Bootstrap Method for Selecting Dynamic Trading Strategies , 1998 .

[8]  Stephen L Taylor,et al.  Rewards Available to Currency Futures Speculators: Compensation for Risk or Evidence of Inefficient Pricing? , 1992 .

[9]  Marco Tomassini,et al.  Genetic Algorithms with collective sharing for Robust Optimization in Financial Applications , 1996 .

[10]  Perry J. Kaufman,et al.  Commodity trading systems and methods , 1978 .

[11]  B. LeBaron,et al.  Simple Technical Trading Rules and the Stochastic Properties of Stock Returns , 1992 .

[12]  Gordon Leitch,et al.  Economic Forecast Evaluation: Profits versus the Conventional Error Measures , 1991 .

[13]  S. Satchell,et al.  An assessment of the economic value of non‐linear foreign exchange rate forecasts , 1995 .

[14]  E. Fama.  EFFICIENT CAPITAL MARKETS: A REVIEW OF THEORY AND EMPIRICAL WORK* , 1970 .

[15]  M. C. Jensen.  Some Anomalous Evidence Regarding Market Efficiency , 1978 .

[16]  R. Stambaugh,et al.  On the Predictability of Stock Returns: An Asset-Allocation Perspective , 1995 .

[17]  Kalok Chan,et al.  Market Efficiency and the Returns to Technical Analysis , 1998 .

[18]  H. White,et al.  Data‐Snooping, Technical Trading Rule Performance, and the Bootstrap , 1999 .

[19]  Robert Ferguson,et al.  In Defense of Technical Analysis , 1985 .

[20]  Blake LeBaron,et al.  Do Moving Average Trading Rule Results Imply Nonlinearites in Foreign Exchange Markets , 1992 .

[21]  Robert Hudson,et al.  A note on the weak form efficiency of capital markets: The application of simple technical trading rules to UK stock prices - 1935 to 1994 , 1996 .

[22]  Elli Gifford.  Technical Analysis of the Futures Markets , 1990 .

[23]  W. Arthur.  On Learning and Adaptation in the Economy , 1992 .

[24]  Ravi Jagannathan,et al.  Implications of Security Market Data for Models of Dynamic Economies , 1990, Journal of Political Economy.

[25]  Mark P. Taylor,et al.  Charts, Noise and Fundamentals in the London Foreign Exchange Market , 1990 .

[26]  Christopher J. Neely,et al.  Is Technical Analysis in the Foreign Exchange Market Profitable? A Genetic Programming Approach , 1996, Journal of Financial and Quantitative Analysis.

[27]  Lars Peter Hansen,et al.  THE ROLE OF CONDITIONING INFORMATION IN DEDUCING TESTABLE RESTRICTIONS IMPLIED BY DYNAMIC ASSET PRICING MODELS1 , 1987 .

[28]  Stephen F. LeRoy,et al.  Efficient Capital Markets and Martingales , 1989 .

[29]  R. Palmer,et al.  Asset Pricing Under Endogenous Expectations in an Artificial Stock Market , 1996 .

[30]  Maureen O'Hara,et al.  Market Statistics and Technical Analysis: The Role of Volume , 1994 .

[31]  Ellen R. McGrattan,et al.  Money as a medium of exchange in an economy with artificially intelligent agents , 1990 .

[32]  M. Latham..  Informational Efficiency and Information Subsets , 1986 .

[33]  B. LeBaron.  Technical Trading Rules and Regime Shifts in Foreign Exchange , 1991 .

[34]  Ian A. Cooper,et al.  Home Bias in Equity Portfolios, Inflation Hedging, and International Capital Market Equilibrium , 1994 .

[35]  S. Ross.  The Interrelations of Finance and Economics: Theoretical Perspectives , 1987 .

[36]  Richard M. Levich,et al.  The Significance of Technical Trading-Rule Profits in the Foreign Exchange Market: a Bootstrap Approach , 1991 .

[37]  D. McFadden.  Testing for Stochastic Dominance , 1989 .

[38]  Stephen L Taylor,et al.  Trading futures using a channel rule: A study of the predictive power of technical analysis with currency examples , 1994 .

[39]  M. Dacorogna,et al.  Going Back to the Basics - Rethinking Market Efficiency , 1998 .

[40]  J. Proudfoot,et al.  Noise , 1931, The Indian medical gazette.

[41]  F. Diebold,et al.  Further results on forecasting and model selection under asymmetric loss , 1996 .

[42]  Man-kin. Chow,et al.  Technical analysis of the foreign exchange market , 1992 .

[43]  W. Sharpe,et al.  Mean-Variance Analysis in Portfolio Choice and Capital Markets , 1987 .

[44]  R. Cumby,et al.  Testing for market timing ability: A framework for forecast evaluation , 1987 .

[45]  Michael W. Brandt.  Estimating Portfolio and Consumption Choice: A Conditional Euler Equations Approach , 1999 .

[46]  Louis F. Pau.  Technical Analysis for Portfolio Trading by Syntactic Pattern Recognition , 1989 .

[47]  Mark P. Taylor,et al.  The use of technical analysis in the foreign exchange market , 1992 .