Decision-Making in the Foreign Exchange and Bond Markets

Abstract

There are virtually as many techniques of exchange rate analysis and forecasting as there are currencies. These range from the judgemental or ‘kitchen sink’ approach to highly sophisticated econometric and technical models. This diversity makes life difficult in decision-making regarding foreign exchange. There are probably several steps, however, involved in reaching some practical conclusion regarding currency behaviour. First, it is important to have a clear idea regarding what constitutes a relevant theoretical model of exchange rate determination. Secondly, within the constructs of that model, it is important to distinguish between the ‘equilibrium’ exchange rate and an exchange rate’s dynamic path once it has been disturbed. Thirdly, it is essential to realise that events other than those captured by macro- or micro-economic analysis can influence exchange rate behaviour. It is necessary to have an approach which accommodates this. In many ways, a similar set of remarks can be applied to the analysis of interest rates. This paper illustrates how we, at Goldman Sachs, have approached the issue of decision-making in the foreign exchange and foreign bond markets.