foreign exchange rate forecasting_s.pptx

Implies that the forecast for tomorrows exchange rate

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Implies that the forecast for tomorrow’s exchange rate is today’s (spot) exchange rate or today’s forward rate for tomorrow.
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13 Market-based forecasting Use the current market spot and forward rates as forecasters for the future spot rate This means that market-based forecasts are free and readily available This is because future spot rates are expected to follow random walk model , which states that the best forecast for tomorrow exchange rate is todays exchange rate. And forward rates offers Forward Market Efficiency if the expected spot rate in future is equal to forward rate. And that we cannot improve upon the predicted spot rate in future what forward rate has to offer. So that Forward rate is an unbiased & efficient predictor of the future spot rate: . Does Market Efficiency hold? Look at the USD/AUD spot rate against the forward one month rate. we can see how forward rate tracks the future spot rate so well! I have subtracted 0.1 from the forward rate so we can see the tracking of future spot rate by the forward rate. 0 0.2 0.4 0.6 0.8 1 1.2 The spot and forward rate (1m) Spot rate-0.1 Forward rate
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14 Judgmental forecasting Its an informal method since it is not based on a formula derived from a formal model. But it takes into account all factors (economic, otherwise, not quantifiable like market sentiments) affecting exchange rates Judgmental forecasts normally takes the form of directional change (for e.g. interest rate to go up or down in the next RBA announcement), and informal prediction interval and not the point forecast (for e.g. EPS of a company will be between 1- 5cents). Judgmental forecasts can be used to improve the formal forecasts. Modify formal forecasts (based on experience) if they look nonsensical (either too high or too low) to look them more appealing. Judgmental forecasts may also be used within formal method of forecasting
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15 Composite forecasting Composite forecasting is based on two or more forecasts that are derived independently Purpose: Forecasting accuracy can be improved by pooling different forecasts (say and ), and driving some sort of an average or consensus forecast. Why? Diversification reduces the risk of large forecasting errors. Different forecasters have different degrees of forecasting accuracy. The difference in forecasts in general could be due to variety of reasons. Different methods/technique (econometrics vs. time series models) Different econometric models: one explanatory variable vs. two etc. and linear vs non-linear models. Same model, different estimation methods (produce different parameter estimates of the model). Different samples of historical data for model estimation.
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16 Forecasting performance evaluation Forecasts may pertain to a position or an investment that involves millions of $. Right forecast is of crucial importance for profitability.
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