SPA-test. However, if the Sharpe ratio criterion is used to select the best strategy, then for one fourth of the indices, mainly the Asian ones, the null hypothesis of no superior forecastability is rejected by the SPA-test, even in the presence of 1% transaction costs. Finally, the recursive optimizing and testing method does show out-of-sample forecasting profits, also in the presence of transaction costs, mainly for the Asian, Latin American, Middle East and Russian stock market indices. However, for the US, Japanese and most Western European stock market indices the recursive out-of-sample forecasting procedure does not show to be profitable, after implementing little transaction costs. Moreover, for sufficiently high transaction costs it is found, by estimating CAPMs, that technical trading shows no statistically significant risk-corrected out-of-sample forecasting power for almost all of the stock market indices. Only for low transaction costs (≤ 0.25% per trade) economically and statistically significant risk-corrected out-of-sample forecasting power of trend-following technical trading techniques is found for the Asian, Latin American, Middle East and Russian stock market indices.
In Chapter 6 a financial market model with heterogeneous adaptively learning agents is developed. The agents can choose between a fundamental forecasting rule and a technical trading rule. The fundamental forecasting rule predicts that the price returns back to the fundamental value with a certain speed, whereas the technical trading rule is based on moving averages. The model in this chapter extends the Brock and Hommes (1998) heterogeneous agents model by adding a moving-average technical trading strategy to the set of beliefs the agents can choose from, but deviates by assuming constant relative risk aversion, so that agents choosing the same forecasting rule invest the same fraction of their wealth in the risky asset. The local dynamical behavior of the model around the fundamental steady state is studied by varying the values of the model parameters. A mixture of theoretical and numerical methods is used to analyze the dynamics. In particular we show that the fundamental steady state may become unstable due to a Hopf bifurcation. The interaction between fundamentalists and technical traders may thus cause prices to deviate from their fundamental value. In this heterogeneous world the fundamental traders are not able to drive the moving average traders out of the market, but fundamentalists and technical analysts coexist forever with their relative importance changing over time.