Predicting exchange rates in Asia: New insights on the accuracy of survey forecasts

• Published date: 01 March 2020
• DOI: http://doi.org/10.1002/for.2628
• Date: 01 March 2020
• Author: Frederik Kunze

Received: 30 November 2017 Revised: 4 October 2018 Accepted: 23 July 2019

DOI: 10.1002/for.2628

SPECIAL ISSUE ARTICLE

Predicting exchange rates in Asia: New insights on the

accuracy of survey forecasts

Frederik Kunze

NORD/LB Norddeutsche Landesbank

Girozentrale, Hanover,Germany

Correspondence

Frederik Kunze, NORD/LB Norddeutsche

Landesbank Girozentrale, 30159 Hanover,

Germany.

Email: frederik.kunze@nordlb.de

Abstract

By linking measures of forecast accuracy as well as testing procedures with

regard to forecast rationality this paper investigates aggregated survey forecasts

with forecast horizons of 3, 12, and 24 months for the exchange rates of the

Chinese yuan, the Hong Kong dollar, the Japanese yen, and the Singapore dol-

lar vis-à-vis the US dollar and, hence, for four different currency regimes. The

rationality of the exchange rate predictions is initially assessed utilizing tests for

unbiasedness and efficiency which indicate that the investigated forecasts are

irrational in the sense that the predictions are biased. As one major contribution

of this paper, it is subsequently shown that these results are not consistent with

an alternative, less restrictive, measure of rationality. Investigating the order of

integration of the time series as well as cointegratingrelationships, this empirical

evidence supports the conclusion that the majority of forecasts are in fact ratio-

nal. Regarding forerunning properties of the predictions, the results are rather

mediocre, with shorter term forecasts for the tightly managed USD/CNY FX

regime being one exception. As one additional important and novel evaluation

result, it can be concluded, that the currency regime matters for the quality of

exchange rate forecasts.

KEYWORDS

Exchange rates, survey forecasts, forecast evaluation, forecast accuracy,forecast rationality, cointe-

gration, impulse response analysis

JEL CLASSIFICATION

F31, F37, G17, O24

1INTRODUCTION

The foreign exchange (FX) market belongs to

the largest financial markets globally (see, for

example,Sosvilla-Rivero & Ramos-Herrera, 2013). Addi-

tionally, exchange rates are crucial price variables in

open economies and international finance (see Dreger &

Stadtmann, 2008; Dick et al., 2015) and have a significant

impact on foreign trade and cross border investments

(see, for example, Kan, 2017). Hence, the understanding

of the price building processes as well as the statistical

validation of well-known presuppositions for functional

and efficient FX markets (i.e. particularly rationality of

market participants) are relevant for political and man-

agerial decision-makers in general and for forecasters in

particular (see, for example, Ince & Molodtsova, 2017).

Journal of Forecasting. 2020;39:313–333. wileyonlinelibrary.com/journal/for © 2019 John Wiley & Sons, Ltd. 313

KUNZE

In this context, the chosen FX regime also plays a crucial

role.1This is also true for Asian currencies, because with

respect to global GDP growth, cross border investments

and world trade Asia's economies are becoming increas-

ingly important, and, in recent years, asset managers

outside Asia, seeking to diversify their investment posi-

tions, are focusing on Asia's financial markets (see, for

example, Dunis & Shannon, 2005).

During the global financial crisis, various currencies

have been under pressure of a pronounced and unantic-

ipated appreciation of the US dollar (Fratzscher, 2009).

These movements are a potential source of severe eco-

nomic and financial consequences, because uncertainty

regarding exchange rate movements might hinder eco-

nomic activity including cross border trade (see, for

example, Thorbecke, 2008; Chit et al., 2010). Focusing on

Asian markets, Hayakawa and Kimura (2009) show that

especially in East Asia intra-regional trade is negatively

affected by FX volatility. In addition to that, both foreign

and domestic companies have to deal with currency risk

(see Aggarwal et al., 2011; Aggarwal, 2013). De Grauwe

and Markiewicz (2013) note that especially in non-US

equity markets, and in certain sub-periods, currency risk

has been the major driver of risk premiums in the stock

market. Since currency risk is non-neglectable, FX fore-

casts may create economic value for financial market par-

ticipants, central banks, policy decision-makers as well

as importers and exporters, respectively. Following Duffy

and Giddy (1975), FX forecasts have to be seen as “signif-

icant inputs to decisions concerning practically every aspect

of international business” (see Duffy and Giddy,1975, p. 1).

Survey forecasts for financial market variablesin general

and FX rates in special are relevant for decision-makers

due to various reasons. First of all, survey forecasts have

to be seen as one reasonable alternative for self-produced

predictions – especially when decision-makers have not

sufficient resources to perform forecasting exercises

for numerous financial market variables on a regular

basis. Additionally, when focusing on the combination

of forecasts delivered to a survey, the superiority of

combined forecasts has been discussed intensively in the

academic literature (see, for example, Bates & Granger,

1969; Clements & Harvey, 2011; Blanc & Setzer, 2016).

1Despite the fact that presently the majority of scholars and – according

to what they say – policy makers do favor flexibleFX regimes, the choice

of the FX regime apparently still matters for economic outcomes. Hence,

decision-makers of various kinds have to cope with the question of the

appropriate FX regime or FX policy, respectively. Focusing on flexible

FX rates or free floats, Basse (2006), for example, emphasizes the rele-

vanceof the choice of the FX regime for monetary policy decision-makers.

Whereas Aysun (2008) – despite not advocating the choice of using a

hard peg – discusses the economic benefits from limiting exchange rate

fluctuations for emerging markets.

Moreover, and most importantly in the context of this

study, one outstanding additional benefit of survey

forecasts in comparison to other prediction methods

stems from the fact, that survey forecasts may be utilized

as an approximation for market participants' expectation

formations (MacDonald & Torrance, 1988; Jongen et al.,

2008). And finally, although not being in the focus of

this paper, it is important to note, that recently survey

forecasts have been utilized to get insights on financial

market uncertainty (see, for example, Lahiri & Sheng,

2010; Poncela & Senra, 2017).

Owing to the growing importance of Asia's major

economies and the region's most important financial

centers as well as the relevance of survey forecasts for

decision-makers, this paper focuses on the investigation of

survey forecasts for exchange rates of the Chinese yuan,

the Hong Kong dollar, the Japanese yen, and the Singa-

pore dollar vis-à-vis the US dollar. Somewhat surprising,

in the context of forecast evaluation, empirical research

focusing on these particularly relevant Asian FX marketsis

rather scarce. This is especially true for comparing studies

investigating more than one currency area at a time. Using

measures of forecast accuracy, common tests for ratio-

nality (i.e. unbiasedness and efficiency), as well methods

of applied time series analysis (i.e. cointegration analy-

sis and impulse response functions), the quality of survey

forecasts for these exchange rates is assessed. As a con-

sequence of significant differences in FX regimes in the

currency areas under investigation, it is also examined

whether there exists empirical evidence for regime depen-

dent variations in the quality – or, to be more precise, in

the accuracy and rationality – of survey forecasts.

Given the relevance of the FX regime on the price build-

ing processes for exchange rates, it is expected that survey

forecasts do vary regarding accuracy and rationality. For

forecasters classifying the relevant exchange rate regime

is a crucial step (see, for example, Von Spreckelsen et al.,

2014). Against the background of a strong influence of pol-

icy makers on exchange rates in managed FX regimes and

the statutory provisions in currency boards it is standing

to reason, that fixed and strongly managed exchange rates

are “easier” to forecast, because policy makers are follow-

ing an anticipated or even mandatory agenda. On the other

hand, free float FX regimes seem to lack these policy guide-

lines which makes it more difficult to forecast the future

path of exchange rates.

While focusing on the investigation of survey based

exchange rate forecasts provided by Consensus Economics

for four different currency regimes, this paper combines

two strands of research: the evaluation of survey fore-

casts for exchange rates and the analysis of FX regime

dependent characteristics. The motivation of this investi-

gation is twofold. Firstly, it seeks to deliver an up-to-date

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