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Evaluating Dynamic Trading Strategies:
The free lunch was no banquet
Eric Jacquier
Carroll School of Management, Boston College and CIRANO
Tong Yao∗
Eller School of Business, University of Arizona
First draft: December 1999
This version: August 2002
Abstract
We examine the issues of evaluating the performance of technical trading rules applied to daily
equity and exchange rates. First, we document the ability of the rules to predict mean, variance and higher
moments of returns. Second, we contrast these often used measures with alternates more closely tied to
the profitability of the rules, such as excess return on the buy-and-hold strategy and Sharpe ratio. While,
as found by others, the evidence of predictability is statistically strong on very long samples of data, that
on profitability is weaker. Third, we turn show that for realistic horizons below 10 years, the rules then
do not consistently beat the buy-and-hold strategy. Moreover, when we consider measures of persistence in
performance, the evidence is further weakened. Last, we incorporate the potential for data-snooping into the
analysis. We use genetic algorithms, in a novel way, to quantify the effect of data-snooping in the evaluation
of trading rules. We find that at horizons below 10 years, the bias due to data-snooping is so large that no
true economic profitability remains. We also show that even sophisticated algorithms would have failed to
yield profits in past 20 years. While we agree with others that ”the party may have ended”, our results show
that any prior free lunch was no banquet.
JEL Classification: C12, C15, C63, G14.
Key words: Data mining, Efficient markets, Genetic algorithm, Moving average, Technical
analysis, Trading rule.
∗
The authors can be contacted at [email protected] and [email protected]. Updates of this
paper will be posted on: jacquier.bc.edu:8080/www. This paper has benefitted from discussions with Bill
Goetzmann, Blake LeBaron and Paul Weller.