MultiBusinessFinancecha10.pptVIP

Chapter 10 Foreign Exchange Rate Determination and Forecasting Foreign Exchange Rate Determination Exchange rate determination is complex. The following exhibit provides an overview of the many determinants of exchange rates. This road map is first organized by the three major schools of thought (parity conditions, balance of payments approach, asset market approach), and secondly by the individual drivers within those approaches. These are not competing theories but rather complementary theories. Foreign Exchange Rate Determination Without the depth and breadth of the various approaches combined, our ability to capture the complexity of the global market for currencies is lost. In addition to gaining an understanding of the basic theories, it is equally important to gain a working knowledge of: the complexities of international political economy; societal and economic infrastructures; and, random political, economic, or social events affect the exchange rate markets. Exhibit 10.1 The Determinants of Foreign Exchange Rates Exchange Rate Determination: The Theoretical Thread The previous exhibit, with its tripartite categorization of exchange rate theory is a good start but – in our humble opinion – is not robust enough to capture the multitude of theories and approaches. Therefore, in the following slides, we will introduce several additional streams of thought. Exchange Rate Determination: The Theoretical Thread The theory of purchasing power parity is the most widely accepted theory of all exchange rate determination theories: PPP is the oldest and most widely followed of the exchange rate theories. Most exchange rate determination theories have PPP elements embedded within their frameworks. PPP calculations and forecasts are however plagued with structural differences across countries and significant data challenges in estimation. Exchange Rate Determination: The Theoretical Thread The balance of payments approach is the second most utilized theoretical