Three-month Exchange Rate Forecasting between USD and JPY

Abstract This paper aims at the forecast of USD-JPY exchange rate on 1st May, 2012 based on the data collected before 1st Feb. 2012. The result proves satisfactory predictions when summarize using the fundamental forecasting, market-based forecasting and mixed forecasting all into consideration. The use of PPP gives the most accurate prediction comparing with the real rate of 1st May, 2012, though the exchange rate is actually affected by several other facets. The paper further discusses the advantages and lack points of each method, so that the forecasting errors can be comprehended.

Key Words
Exchange Rate Forecasting Regression Analysis PPP IFE Forecasting Error

Introduction

With the development of our society, globalization has become an inevitable trend. Since the late twentieth century, financial permeation has become a profound and widespread issue. Exchange rate, an important link of international financial relationship, has almost penetrated into every corner of economics and played an increasingly significant role in our life. Therefore, it is of great meaning for investment and management to forecast the exchange rate.

Ever since Meese and Rogoff (1983) initiated the research on out-of-sample forecasting that has become standard procedure for exchange-rate model validation, work in this area has discovered three things. First, the particular time-period of the sample matters. Fundamentals-based models showed good ability to forecast exchange rates during the 1980s and early 1990s (Mark, 1995 and Chinn and Meese, 1995) but that predictive ability declined as observations from the 1990s and 2000s became available (Groen, 1999, Cheung et al., 2005). Second, the choice of fundamentals seems to matter. Earlier research focused on monetary and purchasing power parity