Four essays in quantitative analysis: artificial intelligence and statistical inference

This thesis consists of four essays exploring quantitative methods for investment analysis. Chapter 1 is an introduction to the topic where the backgrounds, motivations and contributions of the thesis are discussed. This Chapter proposes an expert system paradigm which accommodates the methodology for all four empirical studies presented in Chapters 2 to 5. In Chapter 2 the profitability of technical analysis and Bayesian Statistics in trading the EUR/USD, GBP/USD, and USD/JPY exchange rates are examined. For this purpose, seven thousand eight hundred forty-six technical rules are generated, and their profitability is assessed through a novel data snooping procedure. Then, the most promising rules are combined with a Naïve Bayes (NB), a Relevance Vector Machine (RVM), a Dynamic Model Averaging (DMA), a Dynamic Model Selection (DMS) and a Bayesian regularised Neural Network (BNN) model. The findings show that technical analysis has value in Foreign eXchange (FX) trading, but the profit margins are small. On the other hand, Bayesian Statistics seems to increase the profitability of technical rules up to four times. Chapter 3 introduces the concept of Conditional Fuzzy (CF) inference. The proposed approach is able to deduct Fuzzy Rules (FRs) conditional to a set of restrictions. This conditional rule selection discards weak rules and the generated forecasts are based only on the most powerful ones. In order to achieve this, an RVM is used to extract the most relevant subset of predictors as the CF inputs. Through this process, it is capable of achieving higher forecasting performance and improving the interpretability of the underlying system. The CF concept is applied in a betting application on football games of three main European championships. CF’s performance in terms of accuracy and profitability over the In-Sample (IS) and Out-Of-Sample (OOS) are benchmarked against the single RVM and an Adaptive Neuro-Fuzzy Inference System (ANFIS) fed with the same CF inputs and an Ordered Probit (OP) fed with the full set of predictors. The results demonstrate that the CF is providing higher statistical accuracy than its benchmarks, while it is offering substantial profits in the designed betting simulation. Chapter 4 proposes the Discrete False Discovery Rate (DFDR+/-) as an approach to compare a large number of hypotheses at the same time. The presented method limits the probability of having lucky findings and accounts for the dependence between candidate models. The performance of this approach is assessed by backtesting the predictive power of technical analysis in stock markets. A pool of twenty-one thousand technical rules is tested for a positive Sharpe ratio. The surviving technical rules are used to construct dynamic portfolios. Twelve categorical and country-specific Morgan Stanley Capital International (MSCI) indexes are examined over ten years (2006-2015). There are three main findings. First, the proposed method has high power in detecting the profitable trading strategies and the time-related anomalies across the chosen financial markets. Second, the emerging and frontier markets are more profitable than the developed markets despite having higher transaction costs. Finally, for a successful portfolio management, it is vital to rebalance the portfolios on a monthly basis or more frequently. Chapter 5 undertakes an extensive investigation of volatility models for six securities in FX, stock index and commodity markets, using daily one-step-ahead forecasts over five years. A discrete false discovery controlling procedure is employed to study one thousand five hundred and twelve volatility models from twenty classes of Generalized AutoRegressive Conditional Heteroskedasticity (GARCH), Exponential Weighted Moving Average (EWMA), Stochastic Volatility (SV), and Heterogeneous AutoRegressive (HAR) families. The results indicate significant differences in forecasting conditional variance. The most accurate models vary across the three market categories and depend on the study period and measurement scale. Time-varying means, Integrated GARCH (IGARCH) and SV, as well as fat-tailed innovation distributions are the dominant specifications for the outperforming models compared to three benchmarks of ARCH (1), GARCH (1,1), and the volatility pool’s 90th percentile. Finally, Chapter 6 puts together the main findings from the four essays and presents the concluding marks