An analyst estimates the following exchange rate model for the yen currency against the dollar: Expected rate of appreciation of yen against the dollart(%)= =0.1[idollart-2(%) – iyent-2(%)]+0.5[idollart-1(%) – iyent-1(%)]+1.0[idollar(%)t – iyen(%)t]2+ +0.1[GDPJAPt(%) – GDPUSt(%)]. In this model, idollart(%) is the one-year interest rate in the US in period t, iyent(%) is the one-year interest rate in Japan in period t, idollart-1(%) is the one-year interest rate in the US in period t-1, iyent-1(%) is the one-year interest rate in Japan in period t-1, idollart-2(%) is the one-year interest rate in the US in period t-2, iyent-2(%) is the one-year interest rate in Japan in period t-2,GDPUSt(%) refers to annual GDP growth in the US in period t and GDPJAP(%) refers to annual GDP growth in Japan in period t. Assume idollart-2=4%, iyent-2=2%,idollart-1=5%, iyent-1=3%, GDPUSt=3% and GDPJAPt=1%. Calculate the one-year interest rate differential idollar(%)t – iyen(%)t that delivers an expected rate of appreciation of the yen against the dollar of 5.8% in period t. Briefly comment on your finding
Expected rate of appreciation of yen against the dollart(%)=
=0.1[idollart-2(%) – iyent-2(%)]+0.5[idollart-1(%) – iyent-1(%)]+1.0[idollar(%)t – iyen(%)t]2+
+0.1[GDPJAPt(%) – GDPUSt(%)].
In this model, idollart(%) is the one-year interest rate in the US in period t, iyent(%) is the one-year interest rate in Japan in period t, idollart-1(%) is the one-year interest rate in the US in period t-1, iyent-1(%) is the one-year interest rate in Japan in period t-1, idollart-2(%) is the one-year interest rate in the US in period t-2, iyent-2(%) is the one-year interest rate in Japan in period t-2,GDPUSt(%) refers to annual
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