Sunday, 16 August 2020

Currency Forecasting

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Currency Forecasting

 

 

At the cornerstone of international finance relations, there are three international interest

parity conditions, viz., the covered interest parity, the PPP doctrine and the international

fisher effect.

These parity conditions indicate degree of market integration of the domestic economy

with the rest of the world.

The PPP theory focuses on the inflation-exchange rate relationship. Substantial empirical

research has been done to test the validity of PPP theory.

The general consensus has been that PPP does not accurately predict future exchange rates

and there are significant deviations from PPP persisting for lengthy periods.

The IFE uses interest rates rather than inflation rate differential to explain the changes in

exchange rates over time.

IFE is closely related to PPP because interest rates are significantly correlated with inflation

rates.

 

 

Absolute PPP Theory: Absolute PPP theory postulates that the equilibrium exchange rate between

currencies of two countries is equal to the ratio of the price levels in the two nations.

Table 1: Differences in Relative Inflation Rates and

Currency Depreciation, 1973-2001

Notes Arbitrage: The simultaneous purchase and sale of an asset in order to profit from a difference in

the price. It is a trade that profits by exploiting price differences of identical or similar financial

instruments, on different markets or in different forms.

Hedge: Making an investment to reduce the risk of adverse price movements in an asset. Normally,

a hedge consists of taking an offsetting position in a related security, such as a futures contract.

Interest Parity: Interest rate parity relates interest rates and exchange rates.

International Fisher Effect: The IFE uses interest rates rather than inflation rate differential to

explain the changes in exchange rates over time.

Purchasing Power Parity theory: The PPP theory focuses on the inflation-exchange rate

relationships.

Relative form of PPP Theory: Relative form of PPP theory is an alternative version which

postulates that the change in the exchange rate over a period of time should be proportional to

the relative change in the price levels in the two nations over the same time period.

Speculation: Taking large risks, especially with respect to trying to predict the future; gambling,

in the hopes of making quick, large gains.

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