Class Notes 7 EXCHANGE RATE FORECASTING
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1 Inernaonal Fnance FINA 342 Dr. Angela Ng HKUST Class Noes 7 EXCHANGE RATE FORECASTING I. MARKET-BASED FORECASTS Marke-based exchange rae forecass combne he nernaonal ar condons wh marke rces. Forward Par or Unbased Execaons Hohess Use he unbased naure of forward raes. E[S d/f ] = F d/f Execed fuure so rae a me = Forward rae ha maures a me, whch he rce s known oda. However, forecasng horzon s lmed for abou ear wh forward raes, because forward raes ha have horzons longer han ear are no alwas obanable. Le s be he ercenage change n he so exchange rae and FP be he forward remum. Then he forward ar requres s = α + β FP + e Forward ar redcs ha α = and β =.
2 Ineres Rae Par and Exchange Rae Deermnaon Recall: IRP relaonsh s gven b or F F Combnng wh he forward ar gves or E S [ S ] = E S [ ] Execaon las a ke role n exchange rae deermnaon. Exchange rae behavor s drven b news evens. PPP and Exchange Rae Deermnaon From he relave PPP relaonsh, we oban or E + [ ] + E S [ S ]
3 Absolue PPP and Quan Theor of Mone Absolue PPP: S = P P Quan heor of mone: P = P = M V M V The monear aroach s based on PPP and he quan heor of mone,.e., S M = M V V The monear aroach can be vewed as a long-run heor, no a shor-run heor, of exchange rae deermnaon. II. MODEL-BASED FORECASTS Fundamenal Analss Use macroeconomc daa o redc fuure exchange rae changes. Examle: Monear aroach s = α + β (m m * ) + β 2 (v v * ) + β 3 ( * ) Dffcules One has o forecas a se of ndeenden varables o forecas he exchange raes. The arameer values ha are esmaed usng hsorcal daa ma change over me. 3
4 Techncal Analss Use as nformaon of rces or exchange raes and radng volume. Ths echnque s also called charng. I reles on varous aerns of rce movemens, ncludng rend and movng averages. Some forecasng servces use echncal analss o redc exchange rae movemens. The grahcall record he acual radng hsor of he currenc and r o nfer ossble fuure rends based on ha nformaon alone. The analss s echncal n he sense ha does no rel on an fundamenal analss of he underlng economc deermnans of exchange raes, bu onl on he exraolaons of as rce rends. Ths forecasng mehod s call used for ver shor-erm analss such as nrada or weekl forecass. Techncal radng rules based on as exchange raes: () Fler rule () Movng average rule Fler Mehods Fler rules are radng sraeges based on he as hsor of an asse rce ha rovdes sgnals o an nvesor ndcang when o bu and sell. Fler rules generae bu sgnals when an exchange rae rses N% (he fler) above s mos recen rough, and sell sgnals when falls N% below he revous eak. See Exhb 7. 4
5 Numercal examle: Monh So (/ ) neres rae neres rae.5 5%.a. 8%.a Movng Average Rule An (Y,Z) movng average crossover rule goes long (shor) n he foregn currenc when he shor-erm movng average of as rces (based on he mos recen Y das) crosses he long-erm movng average (based on Z ervous das) from below (above). Common movng average rules are (,5), (,2), (5,2). See Exhb 7.2 When he shor-erm movng average exceeds he long-erm movng average, he currenc s value n he recen as exceeds s value n he more dsan as, ndcang ha an uward rend s develong. The sgnals from a movng average rule could enal frequen radng, when he long-erm movng average crosses he so exchange rae a several ons. 5
6 S/ Exhb 7. Fler Rule -% SELL +% BUY Trough Peak Tme Exhb 7.2 Movng Average Rule S/ Long-erm movng average SELL S hor-erm movng average BUY Tme 6
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