The Forecasting of Spot Exchange Rates Based on the Forward Exchange Rates

Radim Gottwald ()
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Radim Gottwald: Department of Finance, Faculty of Business and Economics, Mendel University in Brno

No 2015-52, MENDELU Working Papers in Business and Economics from Mendel University in Brno, Faculty of Business and Economics

Abstract: The forecasting power of forward exchange rates for future spot exchange rates has been investigated by many researchers. In this paper, the author focuses on this topical economic theme too, and investigates the extent, to which the future spot exchange rates could be forecasted based on the current forward exchange rates. The paper aims at an assessment of the forecasting of spot USD/EUR exchange rates based on the forward exchange rates in the period from 2005 to 2013. Graphical and regression analyses are used to investigate the relationship between daily closing spot and forward rates, namely between 3 month rates and 6 month rates. The ordinary least squares method is used in order to forecast the chosen parameters. Hypotheses related to these parameters are tested at a significance level of 5%. By means of the augmented Dickey-Fuller test for a unit root in a time series sample, the author investigates whether the time series of the parameters is stationary. Afterwards, the time series is detrended in order to guarantee stationarity. Transformation into a non-linear econometric model with integrated autoregressive process AR(1) is used in order to reduce high positive autocorrelation in the residuals of the model. Thereafter, forecasts of the detrended model are made. Results revealed the following findings. According to the graphical analysis, the current forward exchange rates probably cannot be considered sufficiently reliable forecasters of the future spot exchange rates. According to the regression analysis, the forward forecasts even systematically undervalue the future spot exchange rates. Summarized, the current forward exchange rates cannot be considered sufficiently reliable forecasters of the future spot exchange rates. The above-mentioned findings are important for financial analysts working in financial companies or enterprises, which import or export some products, thus trading with foreign business partners using foreign currencies. Speculators on foreign exchange markets could make use of the presented findings as well.

Keywords: Forward exchange rate; spot exchange rate; rational expectations theory; currency pair; FOREX (search for similar items in EconPapers)
JEL-codes: C53 F31 O24 (search for similar items in EconPapers)
Pages: 20
Date: 2015-04
New Economics Papers: this item is included in nep-for and nep-mon
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