exchange rate forecasting

1. I.E (Carbaugh) P. 418
Exchange Rate Forecasting
 Multinational enterprises need short term currency forecasts for a variety of reasons. For
example: Corporations often have for brief periods large amount of cash, used to make bank
deposits in various currencies. Choosing a currency in which to make deposit requires some
idea of
what the currency’s exchange rate will be in future.
 For Multinational enterprises short term forecasting tends to be more widespread than long
term forecasting. Most corporations revise their currency forecast at least every quarter.
 Three Exchange rate forecast made by Morgan Guaranty Trust Company for Dec 31,1999
based on following factors:
a: Real Interest rates
b: Current A/C balance as a % of GDP
c: Deviation of real foreign exchange rate from its long run average rate.
 The need of multinational enterprises and investors for forecasted currency values has
resulted in the emergence of currency firms including Predex, Goldman Sachs, and Wharton
Econometric Forecasting Associates. In addition large banks such as Chase Manhattan Bank
and Citibank have provided free currency forecasts to its clients.
 Most Exchange rate forecasting methods use accepted economic (fundamental) relationships
to formulate a model then it is refined through a Statistical analysis of past data.
In the current system of market determined Exchange rates, currency values fluctuate almost
instantaneously in response to new information regarding changes in interest rates, inflation rates,
money supplies trade balances etc.
Judgemental Forecasts:
They are something known as Subjective or common Sense models. They require the gathering of
wide array of political and economic data and interpretation of this data in terms of timings, direction
and magnitude of exchange rate changes.
Judgemental Forecasts formulate projections based on a thorough examination of individual nations.
They consider economic indicators such as inflation rate and trade data; Technical factors such as

2. potential intervention by a control bank in the foreign exchange market and psychological factors that
relates to one’s feel for the market.
Technical Forecasts
 It involves use of historical Exchange rate data to estimate future values.
 This approach is technical in the sense that it extrapolates from past exchange rate trends and
ignores economic and political determinants of exchange rate movements.
 It encompasses a variety of charting techniques including a currency’s price, cycle or
volatility.
 A common starting point for technical analysis is a chart that plots a trading period’s opening,
high, low and closing prices.
 Time series models are used to analyze moving averages of exchange rates.
Fundamental Analysis
 It involves consideration of macroeconomic variables and policies that are likely to affect a
currency’s value.
 It uses computer based econometric models which are statistical estimates of economic
theories.
 TO generate forecasts econometricians develop models for individual nations that attempt to
incorporate the fundamental variables that underlie exchange rate movements, trade
&investment flows, industrial activity , inflation rates, income levels and so on.
 Econometric Models are best suited in forecasting long term exchange rate trends. This is
because exchange rates in the short term are influenced by many factors that change on a day
to day basis resulting in considerable short term volatility.
Criticism
 Obtaining reliable information on interest rates and inflation is difficult.
 There are always factors affecting exchange rates that cannot easily be quantified (such as
intervention by RBI in currency markets.)