Pursuing a Different Approach to Exchange Rate Prediction-Review of the Nissay Exchange Rate Index-

Yasuyuki Komaki

1.Introduction

Exchange rate trends require constant monitoring. Despite longstanding calls for structuralchange， the economy continues to lie at the mercy of the foreign exchange market. In fact， a¥10 appreciation in the yen's exchange rate against the dollar can cause billions of yen in corporateprofits to evaporate， nullifying years of restructuring efforts.

Despite the exchange rate's crucial importance for the economy， exchange rate prediction is anextremely difficult - if not impossible - task. The exchange rate often fluctuates by two tothree percent on a given day， and normally overshoots theoretically estimated levels. Theshorter the prediction period， the larger the influence of random factors， and hence the moredifficult the prediction. However， one characteristic of the foreign exchange market is thatonce it changes direction， it tends to keep going in the same direction.

Moreover， when daily noises are eliminated， most of the change in direction can be explainedby fundamental factors. Based on this characteristic， we developed the Nissay Exchange RateIndex model， and began announcing monthly predictions for exchange rate trends in May1999.

This paper reconsiders the exchange rate index approach by reviewing past exchange rate theoriesand evaluating their usefulness.

The model's results over the first six months are good overall. Presently (September 1999)， themodel indicates that the yen will remain strong until the end of 1999.