High-frequency Markov switching models in the foreign exchange market

Abstract

This paper estimates two-state Markov models for three daily exchange rate series, and investigates the profitability of following the generated forecasts using the performance of simple chartist trading rules as benchmarks. It is shown that (1) the data are well approximated by Markov models, (2) the performance of previously profitable trading rules has dramatically declined in the 1990s, and (3) the Markov models are unstable and not suitable for forecasting in their current form. Copyright © 2000 John Wiley & Sons, Ltd.