The Future Prospects of the Norwegian Krone
The authors of this blog merrily receive about 82000 Norwegian kroner (NOK, €10 000) every academic year in living support for students from the Government of Norway. As we study in Estonia and do not engage in currency hedging, our standard of living (in economic terms) is subject to the NOK/EUR exchange rate. (Estonia has pegged its currency to the Euro and is most probably joining next year)
Over at Financial Times they report that Credit Suisse has made its currency predictions for the next year and betting on the strength of the krone and selling the Euro. With the budget balance and current account surplus larger than 10 percent of GDP, lowest unemployment rate in Europe and buoyant stock and housing markets Norway looks like a sure bet. It looks like we can expect a lenient new year in Tallinn.
Of course there are certain caveats to such a prediction. Foreign exchange markets are notoriously hard to predict and from what I remember investment banks tend to fare worse than just predicting the current exchange rate. Further, as a small economy, Norway would suffer under the curse of small currencies if a new financial crisis was to arise (which many are predicting). Last, the krone correlates rather well with the oil price which might / might not be a benefit for an eventual speculator.
Thanks go to Radu, a loyal evolution-revolution reader, for sharing the FT-article.
Update (May 4th, 2010): More on the Future Prospects of the Norwegian Krone (it’s still on the way up) – New article
5 comments
One of my teachers made an interesting observation on this problem. Everyone knows that FX-rates are impossible to predict on a significant level, the investment bankers also know this; the best prediction one can make is the current exchange rate. However, every serious bank makes these predictions despite this knowledge. The reasoning behind it is simple. If a customer of the bank calls and asks what their predictions are, they can't say "we don't have a clue, todays price is our best estimate". What will the customer think of such a bank? What will it do to the customer's faith in the bank's analysts?
This might be why FX predictions still exists, even after numerous research papers have proven that FX rates move in random walk and are indeed impossible to predict.
Yes, I really agree that FX is seemingly impossible to predict, but still banks engage in carry trading, I believe for two reasons: that more trading equals more commission and higher profits for the banks. But at the same time they also engage in proprietary trading, this might only be so signalize to customers that we really believe in our own advise and you should too. It could also be that given their immense knowledge of financial data / markets they actually have or believe to have an edge. And after all, who would publish FX predictions that work, rather than trade themselves.
I believe in what Niederhoffer calls the principle of ever-changing cycles, that a strategy might work for some time, but as soon as someone else discovers it, it is futile to try anymore, and you have to change your strategy.
Yes, and the history has shown that carry trades can be profitable for a long periode of time, even several years. However, when the reversal sets in it is so quick and brutal that all the cumulative gains over several years are lost in a very short time. That is exactly what has happened over the last decade or so. The problem you are left with is timing the market. The difficulty in this investment strategy is that you are essentially trying to predict the black swan (i.e. the reversal). I don't believe that any mathematical model will ever be able to predict such an event, so you are left with common sense to make your decisions.
The risk/reward ratio does not seem very attractive in the case of carry trades, so from a risk management perspective one might want to avoid any such investment. But as we all know, greed is a compelling emotion.
[...] in January my dear co-author Jørund wrote a short piece on the future prospects of the Norwegian krone, whereby Evolution-Revolution agreed with Credit Suisse’s prediction that the krone was on [...]
Very nice site! is it yours too
Leave a Comment