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Lecture International finance: An analytical approach (2/e) – Chapter 12: Exchange rate forecasting

The goals of this chapter are: To explain why exchange rate forecasting is needed, to illustrate forecasting techniques, to present empirical evidence on forecasting models, to explain how forecasters are evaluated, to demonstrate how technical analysis is used to generate buy and sell signals. | Chapter 12 Exchange Rate Forecasting Objectives To explain why exchange rate forecasting is needed. To illustrate forecasting techniques. To present empirical evidence on forecasting models. Objectives (cont.) To explain how forecasters are evaluated. To demonstrate how technical analysis is used to generate buy and sell signals. To explain how filter rules and moving average rules work. Definition Forecasting is a formal process of generating expectation. Expectations are implicit forecasts. Why Do We Need Exchange Rate Forecasting? Spot speculation Uncovered interest arbitrage Spot-forward speculation Option speculation Hedging Investment and capital budgeting Why Do We Need Exchange Rate Forecasting? (cont.) Financing decisions Pricing decisions Strategic planning Macroeconomic conditions Central bank intervention Econometric Forecasting Models These are models that are specified on the basis of economic theory and estimated by an econometric method. They are classified into single-equation and multi-equation models. Single-Equation Models The exchange rate (or its rate of change) depends on one or more variables: Examples of Single-Equation Models Problems of Single-Equation Models The ‘black box’ problem Forecasting the explanatory variables Data frequency Structural changes Measurement errors Qualitative variables Multi-Equation Models The ‘black box’ problem can be solved by specifying a multi-equation model. Time Series Models These are based entirely on the history of the exchange rate: Problem with Time Series Models If the FX market is weakly efficient, the exchange rate must follow a random walk. Hence, it is not possible to forecast the exchange rate based on its history. Judgmental Forecasting Judgmental forecasting takes into account all factors affecting exchange rates. It is not based on a formula derived from a formal model. Composite Forecasting Composite forecasting is based on two or more forecasts that are derived independently. Forecasting . | Chapter 12 Exchange Rate Forecasting Objectives To explain why exchange rate forecasting is needed. To illustrate forecasting techniques. To present empirical evidence on forecasting models. Objectives (cont.) To explain how forecasters are evaluated. To demonstrate how technical analysis is used to generate buy and sell signals. To explain how filter rules and moving average rules work. Definition Forecasting is a formal process of generating expectation. Expectations are implicit forecasts. Why Do We Need Exchange Rate Forecasting? Spot speculation Uncovered interest arbitrage Spot-forward speculation Option speculation Hedging Investment and capital budgeting Why Do We Need Exchange Rate Forecasting? (cont.) Financing decisions Pricing decisions Strategic planning Macroeconomic conditions Central bank intervention Econometric Forecasting Models These are models that are specified on the basis of economic theory and estimated by an econometric method. They are classified into .