The Performance of UK Exchange Rate Forecasters

Abstract

There have been many tests of the hypothesis that the forward exchange rate is an unbiased predictor of the future spot exchange rate, see e.g. Hansen and Hodrick (I980), Cornell (I977), Levich (I979), Bilson (I98I), Baillie et al. (I983), and Bailey et al. (I984). Their methodology has been largely, but not exclusively, confined to weak form tests of the joint hypotheses of unbiasedness and efficiency in the foreign-exchange markets. In addition there have been limited attempts to test the accuracy and unbiasedness ofvarious exchange rate forecasting services, e.g. Levich (1 980), Goodman (I 979) and Bilik (i 982). The two issues are clearly related, for if the foreign exchange market is efficient and responds promptly and correctly to new, price-sensitive information, then no trading rule, including one based on foreign exchange rate forecasts, can be profitable. That these services have proliferated in recent years would tend to corroborate the findings of Hansen and Hodrick (I980), Geweke and Feige (I979) and Bilson (I98I) that the forward rate has been largely discredited for most major currencies as the best unbiased predictor of future spot rates. Yet Levich (I979), whose sample consisted largely of US-based exchangerate forecasting services, found that the forward rate tends to outperform the forecast services as far as quantitative accuracy is concerned, although the opposite applies for some services with respect to qualitative (i.e. directional) accuracy. Likewise the main conclusion of Goodman's North American-based study was that forecasts derived from 'technical analysis' outperform the forward rate in qualitative tests while judgmental and econometric forecasts are outperformed by the forward rate. These findings are supported by Bilik. In this paper, we carry out quantitative tests of the accuracy of a number of UK-based exchange-rate forecasts. These forecasts are in the main judgemental and econometric but in practice they are no doubt influenced by recent exchange rate movements. Our sample does not contain, therefore, any forecasts derived from technical analysis. The choice of UK forecasters is intentional. In Section I, we discuss our methodology. Results are reported in Section II and our conclusions are drawn in Section III.