Journal of Applied Finance & Banking

Predictability of Foreign Exchange Rates with the AR(1) Model

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  • Abstract

    Many authors have investigated the possibility of predictability in asset returns, but very little supportive evidence has so far been found in exchange rate returns. This empirical study uses the econometric model ARIMA (1,0,0) to study three different foreign exchange rates, namely the euro and the dollar, the euro and the Hungarian forint and the euro and the Korean won. It is worth mentioning that ARIMA (1,0,0) model is the same as the autoregressive model AR(1), as both of them are made up of one autoregressive parameter and no moving average parameters. The results show that it is not possible to explain and predict all three foreign exchange rates using the autoregressive model. Specifically, the technical rule on transactions ARIMA(1,0,0) is not effective in the case of euro vs dollar but it is effective in the case of euro vs the Hungarian forint and euro v-s the Korean won. Fairly accurate predictions can be made regarding the last two foreign exchange relationships.

    JEL classification numbers: F31, F37, G14
    Keywords: Foreign exchange market; Exchange Rate, Technical Trading, Speculation, forecasting