BERND PAPE Asset Allocation, Multivariate Position Based Trading ...

ACTA WASAENSIA 694.2 Dynamic Models of Fundamentalist Chartist Interactionand Mimetic ContagionSurvey data on exchange rate expectations of professional traders shows consistentlythat financial specialists regard charts of past prices as an important source of informationbeyond the analalysis of economic fundamentals, in particular at short horizons118 . This is even true when traders regard themselves as fundamental investors, as isevident from the following quotation of a respondant in Taylor & Allen (1992):Knowledge of chart signals is essential to all operators as they have a bearingon the action of many market participants . . . This holds true both foroperators who place high priority on technical analysis and for others–likeourselves–who prefer a more fundamental approach.(Taylor & Allen 1992: page 311.)The latter statement highlights that technical analysis or chartism, that is the searchfor patterns in the time series of historical prices in order to generate a price forecast,is intimately connected with herding, that is the imitation of other investors tradesregardless of ones own beliefs and information. Reasons for mimetic contagion amongasset managers include, among others, the desire to infer information from other investorstrades (information based herding), the desire of managers to show quality inparticular in the context of short mandates and frequent performance checks–oftenon peer group benchmarkts or capitalization weighted indices (reputation-based andcompensation-based herding), and dynamic hedging in so-called contingent immunizationor portfolio insurance strategies, which manage portfolios containing risky assetsbasedupontheirrecentperformance 119 .118 see the survey studies cited in footnote 112 on page 66. Evidence for profitability of technicaltrading is provided e.g. in Brock, Lakonishok & LeBaron (1992); Jegadeesh & Titman (1993); Chanet al. (1996); Caginalp & Laurent (1998) and Hogan et al. (2004). Critical discussions regardingout-of-sample performance can be found in Sullivan et al. (1998, 1999) and Schwert (2003).119 see e.g. Bikhchandani & Sharma (2001); Davis (2003) and Hirshleifer & Teoh (2003) for literatureoverviews, and Caparrelli, D’Arcangelis & Cassuto (2004); Hwang & Salmon (2004); Sias (2004);Walter & Weber (2006) for recent evidence.