M.Comm. / The object of this study is to critically appraise the fundamental models, technical methods and statistical techniques that constitute the bulk of exchange rate forecasting methodology. Specifically, can any single approach, or combination of techniques, predict or explain the volatile currency movements characterising exchange rate behaviour in the modern international currency market? International currency markets are indeed complex in nature, and the layperson may be excused for not grasping the distinction between the fundamental, technical and statistical techniques described in the hypothesis. It is vital, however, for the comprehension of this study that the distinction between these approaches be explained, and the logic underlying their individual methodologies examined. It may prima facie seem that this study is based on a contradiction. Surely if one wants to predict an economic variable of any kind, one should refer to the economic theory upon which it is based as the starting point of an analysis. Consequently, if the objective is to forecast the future value of a currency, surely there are a great many economic texts that deal with this very question in voluminous detail. Why, then, should yet another paper be written when so much literature already exists? The answer lies not so much in the scope as in the purpose of this work. The aim of this study can be paraphrased. as follows: to provide a comprehensive and critical examination of the various methods of exchange rate forecasting and to explain why economic theory is still deficient in this important area. The question of whether or not short-term' exchange rates are able to be forecast at all will also be critically examined. This study will attempt to elucidate that while fundamental currency speculation models do provide a certain degree of guidance to currency-traders in their daily prognostications, these models are, in the context of modern capital markets, inadequate. At best, these models will be shown as trackers of long-term exchange rate trends, and not always accurate ones at that. Further, it will be demonstrated that the modern trading floors are characterised (if not defined) by split-second price changes, where the long-term'' can mean a minute, and he who hesitates is lost. It is in this setting that traders must do battle for profit, and where the fundamental models that seem to serve so well in textbooks are anachronisms. The study then shifts its focus to a subset of technical analysis known as charting, the objective being to fill the void which arises due to the fundamental models' inadequacies in the short-term. The charting techniques utilised in this study deviate from their fundamental counterparts in that they attempt to explain future exchangerate trends in terms of past performance. That is, exogenous changes are factored out of the forecasting equation, to give way to a methodology based on trendextrapolation. The performance of these models, especially as they pertain to the medium- and short-term., will then be determined. Finally, in an attempt to supplement the use of charts as a forecasting tool, statistical analysis will be considered. The model utilised in this section will be a rudimentary auto-regressive process. Its simplicity, however, belies its consequence. That is, considering that no ubiquitous statistical model dominates exchange rate theory, it is reasonable to assume that an auto-regressive process, such as the one contributed by this study, will not be subordinate to other, more complex, quantitative offerings. Thus this study attempts to provide the necessary insights in order to perspicaciously 1 It should be noted here that the terms "short-term" and "short run" are interchangeable. For the purposes of consistency, only the former term shall be employed throughout this study. 2 The terms "long-term" and "long run" are also interchangeable. For the purposes of consistency, only the former term shall be employed throughout this study. ascertain the proficiency of statistical analysis as an accurate forecaster of exchange rate fluctuations. All of the models and methods examined in this study adopt a pragmatic acid-test. That is to say, if the predictions made as a result of adherence to the models do not comply accurately and consistently with real findings, then the models themselves should be revised. This revision can be in terms of the time-frame to which the model pertains, the application of the model, or the model itself. It must, however, be stressed that a model whose very raison d'etre lies in its ability to predict exchange rate movements must be able to do so without qualifications or exceptions. The methodology adopted in analysing the models themselves is therefore positive as opposed to normative. Thus, even in the "organised chaos" of the modern exchange rate markets, the application of the models should yield satisfactory results. In other words, despite the unprecedented volumes, speed and volatility of the currencies that are traded in the modern arena, the models themselves should still be able to achieve their purpose - to forecast the extent and direction of changes in the par value of a currency. The next logical question is: what is meant by the "organised chaos", and specifically why should this influence the predictive ability of the fundamental, technical and statistical methods of exchange rate forecasting? The answer to this can be introduced as follows. On an almost daily basis, currency traders move an excess of one trillion dollars throughout the world. Adding to the gravity of this somewhat overwhelming statistic is that most of these are intercomputer transactions occurring instantaneously via inter-bank wire-transfers. In fact, the volume of currency traded is so great that if one were to sum the trading of all the Saudi oil, American wheat, European aircraft and Japanese cars, the monetary result would seem pithy in comparison (Millman, 1995:xxi). It is, however, not only the sheer volumes of currencies traded that characterise the international money markets. It is perhaps more importantly the unanticipated and unparalleled volatility of the markets themselves which provides the greatest quandary for those who conform to 'traditional' methods of exchange rate determination. It is all too common, in fact, for currency prices to change on a minute-to-minute or even second-to-second basis. Exchange rates are thus in a constant state of flux. The significant though infrequent changes of past years have been terminally disposed of. The inception of the microcomputer and the floating exchange rate system currently dominating the greater world economy has irrevocably altered what was considered a flawed order. It is this very metamorphosis which will be examined in detail, specifically how fundamental models have assumed a differing purpose to those used by modern speculators, hedgers and arbitrageurs in their specific fields of application. Thus it will be shown how the changing paradigm of the world economy and consequently the currency trading floors themselves necessitate neoteric predictive powers, that is, the power to forecast currency changes not in terms of years, months or even weeks, but rather in terms of days, minutes and seconds. The object of this thesis will therefore be to show that a definite dichotomy has developed between the exchange rate models espoused in economic textbooks and the techniques upon which the de facto day-to-day buying and selling of currencies depend. The efficacy of this study consequently hinges on one decisive question - is there truly a consistent and precise method of forecasting exchange rates?