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

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Presentation transcript:

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 Compare Models (sign, T-Stat, R 2, MSE) Select Model Project Spot FEX rate 2002

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) 4.Ad-Hoc Model FEX = f(Inflation, Income Growth, Current Account) FEX = f(I, y, CA) 5.Martingale-Random Walk FEX = f(Spot Rate Today) = f(St)

PPP Model Spot Rate Percentage Change (st), st = a + B1(Id-If) + e CurrencyaB 1R2 USD/BP (T-Stat) (0.5568) ( ) USD/DEM (T-Stat) (0.8118) (0.3452) USD/MEX (T-Stat) (0.4485) (0.2395) USD/Yen (T-Stat) ( ) ( ) USD/WON (T-Stat) (0.2277) (4.1893)

MAP Model Spot Rate Percentage Change (st), st = a + B1(yf-yd) + B2(md-mf) +e CurrencyaB 1B 2R2 USD/BP (T-Stat) (0.6478) ( ) ( ) USD/DEM (T-Stat) (0.9263) (0.4438) ( ) USD/MEX (T-Stat) (0.2488) (4.0013) (0.9888) USD/Yen (T-Stat) (-1.657) ( ) (1.6663) USD/WON (T-Stat) (-0.431) (4.7123) (2.1156)

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

Ad-Hoc Model Spot Rate Percentage Change (st), st = a + B1(Id-If) + B2(yf-yd) + B3(USCAg) +e CurrencyaB 1B 2B 3R2 USD/BP (T-Stat) (3.0662) (2.5267) (0.7371) (2.143) USD/DEM (T-Stat) (1.1735) ( ) (0.5274) (-1.017) USD/MEX (T-Stat) (0.2122) (-3.896) ( ) (0.1186) USD/Yen (T-Stat) (-3.448) (3.833) ( ) (-0.584) USD/WON (T-Stat) (-0.746) ( ) (2.5798) (0.0910)

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

Compare Models Out of Sample MSE = 1/n * S(St est. – St act ) 2 Model USD/BPUSD/DEMUSD/MEXUSD/YenUSD/WON PPP MAP FER Ad-hoc RW

USD/BP

Forward Projection Based on the FER Model