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Foreign Exchange Rates

Foreign Exchange Rates. How to Predict? Samuel, Omar, and Zach. Agenda. Review Case Review FEX Rate Models Review Models Output Compare Models MSE Select Best Model Predict FEX 2002. Case. Mr. Ritz’s Models PPP MAP FER Adhoc UK, Germany, Japan, Mexico, Korea

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Foreign Exchange Rates

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  1. Foreign Exchange Rates How to Predict? Samuel, Omar, and Zach

  2. Agenda • Review Case • Review FEX Rate Models • Review Models Output • Compare Models MSE • Select Best Model • Predict FEX 2002

  3. Case • Mr. Ritz’s Models • PPP • MAP • FER • Adhoc • UK, Germany, Japan, Mexico, Korea • Compare Models (sign, T-Stat, R2, MSE) • Select Model • Project Spot FEX rate 2002

  4. Models 1. PPP = Purchase Power Parity Model FEX = f(Inflation) = f(I) 2. MAP = Monetary Asset Approach FEX = f(Income Growth, MS Growth) FEX = f(y,m) 3. Forward Exchange Rate Model FEX = f(Interest Rate) = f(i) • Ad-Hoc Model FEX = f(Inflation, Income Growth, Current Account) FEX = f(I, y, CA) • Martingale-Random Walk FEX = f(Spot Rate Today) = f(St)

  5. Spot Rate Percentage Change (st),1978-1996 st = a + B1(Id-If) + e PPP Model

  6. Spot Rate Percentage Change (st), 1978-1996 st = a + B1(yf-yd) + B2(md-mf) +e MAP Model

  7. FER Model FT = Spot Rate * (1+US Interest Rate*T/360) (1+Foreign Interest Rate* T/360)

  8. Spot Rate Percentage Change (st), 1978-1996 st = a + B1(Id-If) + B2(yf-yd) + B3(USCAg) +e Ad-Hoc Model

  9. Martingale-Random Walk Model FT = St MSE = (ST-St)^2

  10. Out of Sample 1997-1999 MSE = 1/n * S(Stest. – Stact)2 Compare Models

  11. USD/BP

  12. Forward Projection Based on the FER Model 2000-2002

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