Foreign Exchange Rates

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. Ritzs 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
PPP Model

• Spot Rate Percentage Change (st),1978-1996
• st a B1(Id-If) e

6
MAP Model

• Spot Rate Percentage Change (st), 1978-1996
• st a B1(yf-yd) B2(md-mf) e

7
FER Model
FT Spot Rate (1US Interest
RateT/360) (1Foreign Interest
Rate T/360)
8
Ad-Hoc Model

• Spot Rate Percentage Change (st), 1978-1996
• st a B1(Id-If) B2(yf-yd) B3(USCAg) e

9
Martingale-Random Walk Model

• FT St
• MSE (ST-St)2

10
Compare Models

• Out of Sample 1997-1999
• MSE 1/n S(Stest. Stact)2

11
USD/BP
12
Forward Projection

• Based on the FER Model 2000-2002