# Probability Distribution of Forecasts Assume that the following regression model was applied to historical quarterly data: e t = a 0 + a 1 I N T t + a 2 I N F t − 1 + μ t where: e t = percentage change in the exchange rate of the Japanese yen in period t INT t = average real interest rate differential (U.S. interest rate minus Japanese interest rate) over period t INF t − 1 = inflation differential (U.S. inflation rate minus Japanese inflation rate) in the previous period a 0 , a 1 , a 2 = regression coefficients μ t = error term Assume that the regression coefficients were estimated as follows: a 0 = 0.0 a 1 = 0.9 a 2 = 0.8 Also assume that the inflation differential in the most recent period was 3 percent. The real interest rate differential in the upcoming period is forecasted as follows: If Stillwater, Inc., uses this information to forecast the Japanese yen’s exchange rate, what will be the probability distribution of the yen’s percentage change over the upcoming period?

FindFind

### International Financial Management

14th Edition
Publisher: Cengage
ISBN: 9780357130698
FindFind

### International Financial Management

14th Edition
Publisher: Cengage
ISBN: 9780357130698

#### Solutions

Chapter 9, Problem 19QA
Textbook Problem

## Probability Distribution of Forecasts Assume that the following regression model was applied to historical quarterly data: e t = a 0 + a 1 I N T t + a 2 I N F t − 1 + μ t where: e t = percentage change in the exchange rate of the Japanese yen in period t INT t = average real interest rate differential (U.S. interest rate minus Japanese interest rate) over period t INF t − 1 = inflation differential (U.S. inflation rate minus Japanese inflation rate) in the previous period a 0 , a 1 , a 2 = regression coefficients μ t = error termAssume that the regression coefficients were estimated as follows: a 0 = 0.0 a 1 = 0.9 a 2 = 0.8 Also assume that the inflation differential in the most recent period was 3 percent. The real interest rate differential in the upcoming period is forecasted as follows:If Stillwater, Inc., uses this information to forecast the Japanese yen’s exchange rate, what will be the probability distribution of the yen’s percentage change over the upcoming period?

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