Understanding And Forecasting The Foreign Exchange Rate

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In today’s global economy, accuracy in forecasting the foreign exchange rate or some predic- tions of its trend is very important for any future investment. Moreover, continuing volatility in currency values and increasing international transactions require to study and forecast cur- rency movement and exchange rates. Forecasting the exchange rate provides opportunities for exporters and importers to make better decisions considering costs and revenues from interna- tional operations. Understanding and forecasting the foreign exchange rate are specially important for multi- national companies because they make important decisions based on forecasting information. I mention some of these decisions. 1. Pricing decision: forecasting the…show more content…
In this paper, I explain some previous works that have developed fundamental models to analyze the mechanism of financial markets, especially exchange markets. Each model has been structured base on some specifics assumptions. The first model that I look at is the rational-expectation-efficient-market (REEM) model. This model has been used for decades to explain and study the exchange markets. One main assumption is the rational representative which has been used in macroeconomic study and financial market analysis. There are specific elements in this model: a) an agent uses all in- formation to forecast; b) the agent maximizes his utility in an intertemporal framework; c) markets are efficient (De Grauwe and Grimaldi, 2006). In an efficient market, prices fully re- flect all available information and no profit opportunities are left unexploited. Fama (1970) is one of the economist who have established the efficient market theory (hypothesis). He re- viewed the theoretical and empirical literature on the efficient market model. He considered the empirical work concerned with adjustment of security prices to three relevant information sets. First, he discussed weak form tests, in which the information set is historical prices. Second, he discussed semi-strong form tests, in which the concern is whether prices efficiently adjust to the information that is publicly

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