The Establishment of the Forecasting Model for Regime Switching in Time Series

Abstract

Efficient market hypothesis implies that the past price movements do not help forecast future price movements. Thus, it is impossible to consistently benefit by a technical trading strategy. On the other hand, technical analysts claim that the historical price movements are useful in predicting future price movements. These two lines of arguments are mutually contradictory. This paper reasonably assumes that the more efficient markets are, the worse will be the investment performance of technical analysis, and that as financial market‘s trading volume grows and with the elapse of time, the efficiency of markets should improve. This implies that after the launch of a new financial asset, market efficiency would improve with increased trading and elapsed time. In this paper, the duration analysis technique is used as a forecasting model and applied to measure the efficiency of Korean futures market and the won/dollar exchange rate market.