Profits From Currency Futures Based On The Random Walk Hypothesis

Abstract

Since the advent of floating exchange rates in 1973 there has been a debate about what is the best predictor of currency spot rates.  The two most prominent candidates have been the current futures price and the current spot price.  Lee Thomas’ (1985, 1986) basic proposition rests on the argument that if the current spot rate follows a driftless random-walk process, then the spot rate of a currency will not tend toward the rate of the futures contract price.  In other words, the best predictor of the spot rate in the future is today’s spot price and not today’s futures contract price.  The investing strategy indicated by this belief is to simply buy (go long) any futures contract that is below today’s spot price and sell (go short) any contract that is above today’s spot price.  Results from January of 1990 through March of 2003 show that by following this strategy, 63.2% of the trades result in a profit.  Various simulations result in annualized returns from 5.18% to 14.76% and none results in a margin call.