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How exactly do markets adapt? Evidence from the Moving Average Rule in three developed markets

How exactly do markets adapt? Evidence from the Moving Average Rule in three developed markets
How exactly do markets adapt? Evidence from the Moving Average Rule in three developed markets
The seminal study by Brock, Lakonishok and LeBaron (1992) (BLL hereafter) found that the moving average rule had strong predictive power over 90 years in the DJIA, and this result was confirmed by Hudson et al. (1996) for the FT30 in the UK and Chen et al. (2009) for the TOPIX in Japan. However, according to the Adaptive Market Hypothesis, trading rules are only likely to be successful for a limited period of time and, as investors and markets adapt, their predictive power will diminish. We examine the moving average (MA) rule using post-BLL (1987–2013) data and find that after 1986 the rule's predictive power has diminished in all three markets. We investigate the exact process behind the weakening of the predictive power of moving average rules and find that post-1987 markets react to new buy/sell signals not on the days those signals are generated, but the day before. In support of this finding, we show that trading strategies based on anticipation of signals would have yielded superior profits to investors. Hence, trading on anticipated signals constitutes a feasible explanation of price reactions to future, one-day-ahead new signals, and thus in line with the Adaptive Market Hypothesis.
1042-4431
127-147
Urquhart, Andrew
ee369df1-95b5-4cdf-bc24-f1be77357c03
Gebka, Bartosz
0cc0d596-0ce5-45c9-a4dc-5b7c91043ba9
Hudson, Robert
60672e7a-4142-4354-9a41-552a3db97157
Urquhart, Andrew
ee369df1-95b5-4cdf-bc24-f1be77357c03
Gebka, Bartosz
0cc0d596-0ce5-45c9-a4dc-5b7c91043ba9
Hudson, Robert
60672e7a-4142-4354-9a41-552a3db97157

Urquhart, Andrew, Gebka, Bartosz and Hudson, Robert (2015) How exactly do markets adapt? Evidence from the Moving Average Rule in three developed markets. Journal of International Financial Markets, Institutions and Money, 38, 127-147. (doi:10.1016/j.intfin.2015.05.019).

Record type: Article

Abstract

The seminal study by Brock, Lakonishok and LeBaron (1992) (BLL hereafter) found that the moving average rule had strong predictive power over 90 years in the DJIA, and this result was confirmed by Hudson et al. (1996) for the FT30 in the UK and Chen et al. (2009) for the TOPIX in Japan. However, according to the Adaptive Market Hypothesis, trading rules are only likely to be successful for a limited period of time and, as investors and markets adapt, their predictive power will diminish. We examine the moving average (MA) rule using post-BLL (1987–2013) data and find that after 1986 the rule's predictive power has diminished in all three markets. We investigate the exact process behind the weakening of the predictive power of moving average rules and find that post-1987 markets react to new buy/sell signals not on the days those signals are generated, but the day before. In support of this finding, we show that trading strategies based on anticipation of signals would have yielded superior profits to investors. Hence, trading on anticipated signals constitutes a feasible explanation of price reactions to future, one-day-ahead new signals, and thus in line with the Adaptive Market Hypothesis.

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Accepted/In Press date: 14 May 2015
e-pub ahead of print date: 29 May 2015
Published date: September 2015
Organisations: Centre of Excellence for International Banking, Finance & Accounting

Identifiers

Local EPrints ID: 377140
URI: http://eprints.soton.ac.uk/id/eprint/377140
ISSN: 1042-4431
PURE UUID: 28b87c81-8374-4c34-96ff-36f236fa7e93
ORCID for Andrew Urquhart: ORCID iD orcid.org/0000-0001-8834-4243

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Date deposited: 26 May 2015 11:10
Last modified: 28 Apr 2022 02:10

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Author: Andrew Urquhart ORCID iD
Author: Bartosz Gebka
Author: Robert Hudson

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