Can Markov switching models replicate chartist profits in the foreign exchange market?

In this paper we show that the Markov switching model is a relevant statist ical alternative to the classical martingale model for exchange rates. By e xtending the standard Markov switching model we decisively reject the marti ngale model. Moreover, the model generates autocorrelations and linear stru ctures in Line with what is observed in reality. Subsequently, we test whet her this model can explain chartist profits. We find that the extended Mark ov switching model is able to explain the profitability of a simple MA-30 r ule. Finally, we decompose the profitability of the MA-30 rule into a linea r and nonlinear part. We find that, although the implied linear structure o f the Markov model explains a substantial part of the profitability, part o f the profits of the MA-30 rule can be attributed to the specific nonlinear ities implicit in the Markov model. (C) 2001 Elsevier Science Ltd. All righ ts reserved. JEL classification: F31.