Forecasting foreign exchange rates using kernel methods

First, the all-important no free lunch theorems are introduced. Next, kernel methods, support vector machines (SVMs), preprocessing, model selection, feature selection, SVM software and the Fisher kernel are introduced and discussed. A hidden Markov model is trained on foreign exchange data to derive a Fisher kernel for an SVM, the DC algorithm and the Bayes point machine (BPM) are also used to learn the kernel on foreign exchange data. Further, the DC algorithm was used to learn the parameters of the hidden Markov model in the Fisher kernel, creating a hybrid algorithm. The mean net returns were positive for BPM; and BPM, the Fisher kernel, the DC algorithm and the hybrid algorithm were all improvements over a standard SVM in terms of both gross returns and net returns, but none achieved net returns as high as the genetic programming approach employed by Neely, Weller, and Dittmar (1997) and published in Neely, Weller, and Ulrich (2009). Two implementations of SVMs for Windows with semi-automated parameter selection are built.

► An SVM, Fisher kernel, DC algorithm and Bayes point machine are used to forecast FX. ► The DC algorithm is used to learn the parameters of the HMM in the Fisher kernel. ► The novel methods beat the market and improved upon a standard SVM. ► Windows SVM software is written, that include a model/parameter selection tools.