Question

Assume there is a regression model that was able to identify the factors that affected exchange rate movements in a recent four year period. Also, suppose that the sensitivity of the exchange rate’s movements to each factor was precisely quantified.

A) Is there any reason not to expect superior forecasting results from this method in the future? Explain why or why not and use supporting resources.

Answer 1

Yes, there are reasons not to expect superior forecasting results from this method in the future. First of all it will not be possible to make ex-ante forecasts using the regression method as forecasts for predictors that affect the exchange rate movements might not always be available.

Secondly the forecasting model, once it starts getting used by other market participants, will no longer be a good forecasting model. This is because they will take certain actions based on the forecasts provided by the model and these actions will lead the currency values to move immediately and not in the future as predicted and forecasted by the model. This will make the predictions and forecasts of the model redundant.