An empirical evaluation of non-linear trading rules.

In this paper we investigate the profitability of non-linear trading rules based on nearest neighbour (NN) predictors. Applying this investment strategy to the New York Stock Exchange, our results suggest that, taking into account transaction costs, the NN-based trading rule is superior to both a riskadjusted buy-and-hold strategy and a linear ARIMA-based strategy in terms of returns for all of the years studied (1997-2002). Regarding other profitability measures, the NN-based trading rule yields higher Sharpe ratios than the ARIMA-based strategy for all of the years in the sample except for 2001. As for 2001, in 36 out of the 101 cases considered, the ARIMA-based strategy gives higher Sharpe ratios than those from the NN-trading rule, in 18 cases the opposite is true, and in the remaining 36 cases both strategies yield the same ratios.