Question

    Assume that the following regression model was applied to historical quarterly data:

e_t = a₀ + a₁INT_t + a₂INF_t + _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 - Japanese interest rate) over period t

             INF_t =   inflation differential (U.S. inflation rate - Japanese inflation rate) in period t

   a₀, a₁, a₂ =   regression coefficients

                 _t =   error term

      Thus, the estimated regression equation is as follows:

                           ^

                           e_t = 0.001 + 0.90 INT_t + 0.80 INF_t                         R² = 0.85

(0.01)       (0.02)          (0.30)

Please answer the questions below.

a.       If the real interest rate differential was 2%, predict the change in the exchange rate. Which assumption are you making?

b.       If the inflation differential was 1%, predict the change in the exchange rate. Which assumption are you making?

c.       If the real interest and inflation rate differentials were 1% and 2% respectively, predict the change in the exchange rate

d.       What is the meaning of the R-squared?

e.        Finally, determine which regression coefficients are statistically significant

Answer 1

Answer: ----                                                                                    Date: ----1/11/2018