The Concept of FTS Anylysis in Forecasting Trends of Exchange Rate Changes

Abstract

ABSTRACT. The crisis in financial markets has contributed to a significant downturn in the global economy. Significant perturbations and high volatility have also been observed in the forex market. The purpose of this article is to determine which variables from the financial and commodity market affect the exchange rate changes. The article presents the concept of FTS analysis (Fundamental - Technical - Speculative) used to predict the direction of exchange rate changes. The author's FTS concept is a combination of two most popular forecasting methods and an attempt to add (parameterize) information on financial institutions' interventions in the forex market and generally understood speculations. The paper specifies explanatory variables and determines the nature of the occurring interdependencies. The FTS analysis allows for developing a computer system for decision support in the management of foreign exchange risk. At the same time, the paper draws attention to the complexity of the issue and shows possible directions for further research.Keywords: forecasting, econometric model, FTS analysis, exchange rate.(ProQuest: ... denotes formulae omitted.)IntroductionIncreasing international economic cooperation and progressive liberalization of turnover in export and import requires the ability to solve a number of specific problems relating to the risk of exchange rate fluctuations. Changes in exchange rates may cause a decrease in revenues and an increase in costs. Additionally, with large commercial transactions and a significant scale of exchange rate fluctuations, foreign exchange losses arise, absorbing the expected profit and leading to losses, which may in turn threaten the existence of a company.Opening of the national economy made numerous entities choose between the domestic and foreign supply and sales markets. The moment a given entity decides to enter the international arena in search for new sources of supply and sales, traditional knowledge of finance ceases to be sufficient, and it becomes imperative to understand the negative impact of the exchange rate fluctuations on future receivables and payables, which consequently may lead to huge losses, and, in extreme cases, even to bankruptcy (Begg, Fischer & Dornbusch, 2007, p. 554).Undoubtedly, using methods of hedging against currency risk generates costs, and in the case of selecting wrong hedging instruments, they may also lead to financial losses. Therefore, if a company does not only think about comprehensively securing its international transactions, but also about benefitting from changes in the forex market and thus achieving additional profits (achieving profits without incurring additional costs, as in the case of hedging instruments, e.g. the most popular currency options), the most effective method is forecasting changes in the forex market (Diebold, Hahn & Tay, 2006). Therefore, it should be ensured that the forecasts of changes in the forex market be as accurate as possible. However, due to the complexity of the issue and the likely inability to accurately predict the value of the exchange rate, it seems reasonable to simplify the simulation model so that it determines only the direction of change. Namely, to determine whether the trend is going to be positive or negative in relation to another currency. This information will be completely sufficient for the institutions operating in the international markets to make appropriate economic decisions.Assumptions for the FTS analysisForecasting has always constituted a challenge for analysts. The only thing that is certain is that prices in financial markets will remain volatile. Predicting the future is difficult, especially when it comes to exchange rates (McNeil, Frey & Embrechts, 2005). Their exact level in a few days or weeks cannot be forecast, despite an extensive econometric apparatus.Analytical model is a hypothesis or a system of hypotheses which are formulated in a mathematical way (in the form of an equation or a system of equations, respectively), and show fundamental relations between real phenomena analysed (Witkowska, 2005). …