Profitability of Nonlinear Dynamics Under Technical Trading Rules: Evidence from Pacific Basin Stock Markets

• Published in: Emerging markets finance & trade 2009-07, Vol.45 (4), p.13-35
• Main Authors: Krausz, Joshua, Lee, Sa-Young, Nam, Kiseok
• Format: Article
• Language: English
• Subjects: asymmetric reverting property; Autocorrelation; Autoregressive models; Correlation analysis; Emerging markets; Holding period return; nonlinear autoregressive models; Nonlinearity; Pacific Basin stock markets; Parametric models; Predictability; Profitability; Profitability index; Rates of return; Securities trading; Statistical significance; Stock exchanges; Stock market indices; Stock markets; Studies; technical analysis
• ISSN: 1540-496X; 1558-0938
• DOI: 10.2753/REE1540-496X450402

This paper explores a possible link between an asymmetric dynamic process of stock returns and profitable technical trading rules. Using Pacific Basin stock market indexes, we show that the dynamic process of daily index returns is better characterized by nonlinearity arising from an asymmetric reverting property, and that the asymmetric reverting property of stock returns is exploitable in generating profitable buy and sell signals for technical trading rules. We show that the positive (negative) returns from buy (sell) signals are a consequence of trading rules that exploit the asymmetric dynamics of stock returns that revolve around positive (negative) unconditional mean returns under prior positive (negative) return patterns. Our results corroborate the arguments for the usefulness of technical analysis.