Predictability of equity returns during a financial crisis

ABSTRACT

An occurrence of a market crash or a financial crisis has long been considered a cause of market inefficiency. An inefficient market commonly implies return predictability and the existence of profitable opportunities for traders and speculators. Technical analysis has been a popular tool to identify predictable patterns in asset prices. The usefulness of a large universe of technical trading rules popularized in the existing literature on technical analysis is tested when they are applied to a set of equity markets that are generally considered developed and efficient during the two most recent periods of major financial turmoil: the 1997 Asian financial crisis and the 2008 global financial crisis. Three major statistical deficiencies that existing studies on return predictability are commonly criticized for – data snooping bias, nonsynchronicity bias and transaction costs – have been incorporated in the analysis. Technical trading rules are largely unable to yield abnormal excess returns over the passive benchmark after data snooping bias, nonsynchronous pricing and transaction costs are accounted for. Chaotic price movements typical for a volatile market during a financial crisis are likely to have an adverse effect on the performance of active trend chasing trading strategies.

KEYWORDS:

• Market efficiency
• return predictability
• financial crisis
• data snooping
• technical analysis

JEL CLASSIFICATION:

• G14
• G17
• G11
• C12
• C63

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ We follow Sullivan, Timmermann, and White (1999) and adopt a ‘wrap-up’ feature for resampling purposes.