No Forex Model

Since the Nixon Shock, economic theories were not redesigned. Although there are some fresh ideas about what Forex is, there isn’t any unified theory of Forex, a model that describes it for what it is, mathematically. In fact, several papers have been written with the hypothesis that existing ‘models’ are severely flawed, and provide evidence; here’s one:

Roger D. Huang published a paper in 1981 for the American Finance Association with the following abstract:

The variance bounds on exchange rate movements implied by the monetary approach to exchange rate in an efficient foreign exchange market is shown to be violated by sample data. The paper also presents evidence showing that the forecast errors implied by the monetary model can be forecasted using historical data. The results are interpreted to suggest either the incompatibility of the monetary approach with sample data, or an inefficient foreign exchange market or both.

Richard J. Sweeny, in 1986, goes on to claim that there is Alpha in Forex not explainable by risk:

Filter rule profits found in foreign exchange markets in the early days of the current managed float persist in later periods, as shown by statistical tests developed and implemented here. The test is consistent with, but independent of, a wide variety of asset pricing models. The profits found cannot be explained by risk if risk premia are constant over time. Inclusion of the home-foreign interest rate differential in computing profits has little effect on the comparison of filter returns to those of buy-and-hold.

If Forex is truly a reactive solution to a pressured Nixon administration, and still no unified model exists, this indicates that there are large opportunities in trading Forex, like an asset class. These opportunities will exist, and persist, until the floating currency system is replaced by something else (not likely anytime soon), or there is a unified Forex model that becomes widely proliferated as much as “Modern Portfolio Theory ” is.