Jump forecasting in foreign exchange markets a high frequency analysis

Abstract

Using tick data for 14 emerging and developed market currencies covering the period from January 2018 until April 2021, we first detect jumps by Lee and Mykland methodology then apply various machine learning algorithms to forecast out of sample jump occurrences and their direction. Our results show that the arrival and the direction of intraday jumps in the foreign exchange market can be predicted with these algorithms combined with liquidity metrics and technical indicators, even for the Covid pandemic period where volatility in the foreign exchange market is very high. Among all the methods considered, multilayer perceptron has the highest average accuracy for jump prediction overall, followed by support vector machine and random forest methodologies with slightly less average accuracy results. Results are robust to alternative sampling schemes. Accordingly, central bankers can adjust liquidity injection timing with these jump prediction models in the foreign exchange markets where they can try to minimize jump strength if not completely eliminate its occurrence. For investors, having information regarding jump occurrence timings gives an opportunity to hedge against foreign exchange risks more efficiently.