Foreign Exchange Forecasting and Leading Ecomonic Indicators: The U.S. -- Canadian Experience.

UNITED States; CANADA

The relationship between the value of currency or foreign exchange between two nations has been explained by author Ian H. Giddy using four related theories, first, the purchasing power parity theory, second, the interest rate parity theory, third, the interest rate theory of exchange rate expectations, and fourth, the forward rate theory of exchange rate expectations. If these events and the relative changes of these events between two countries, the United States and Canada are related to leading economic indicators, then one can hypothesize a relationship between the relative movements of a country's leading economic indicators and the movement of the foreign exchange rates both spot and forward. The purpose of this paper is to investigate the relationship between leading economic indicators of two countries and the foreign exchange rates of these countries. The forecasting of foreign exchange rates in an efficient market has received considerable attention from both academics and practitioners as evidenced by the extensive nature of the literature discussed in this article. This paper presents an alternative approach to foreign exchange rate forecasting which has not yet become a part of the growing literature on foreign exchange forecasting. The results indicate that a model using leading economic indicators lagged for 5 periods can forecast future exchange rate movements as well as the naive martingale model.