|
University of Johannesburg
Economics and Econometrics
«EFFECTS OF CURRENT EXOGENOUS AND ENDOGENOUS
UNCERTAINTY ON THE ZAR/USD FOR THE NEXT TWO YEARS»
Frankie MBUYAMBA Mwana
200839800
MCom Financial Economics
Abstract:
We propose a new empirical specification of uncertainty on the
exchange rate. Conditional heteroskedasticity is frequently found in the
prediction errors of linear exchange rate models. It is not clear whether such
conditional heteroskedasticity is a characteristic of the true data-generating
process, or whether it indicates misspecification associated with linear
conditional-mean representations. We address this issue by estimating
nonparametrically the conditional-mean functions of nominal South African Rand
to U.S Dollar spot rates, from January2006-July 2010, which are used to produce
in-sample and out-of-sample nonparametric forecasts. Our findings bode poorly
for recent conjectures that exchange rates contain nonlinearities exploitable
for enhanced point prediction.
Keywords:
Nonparametric regression, non-linear autoregressive, Kernel function,
exogenous and endogenous uncertainty.
I. INTRODUCTION
The economist's views about the best exchange rate system to
adopt have changed over the years, particularly because new evidence has
accumulated, as the system has moved through various exchange rate regimes.
When analysing the exchange rate and fundamentals, there are a large number of
alternative models based on economics that have been used to analyse movements
in the spot exchange rate. It's probably known that monetary models in their
various forms have dominated the theoretical and empirical exchange rate
literature, as we shall see these models have been far from successful in
explaining some movement in exchange rate. Indeed there is no consensus among
economists on the appropriate set of economic fundamentals that influence the
exchange rate and this is in part why policy makers have sought to limit by
cooperative arrangements such as the Bretton-Woods and the exchange rate
mechanism in Europe which derives today in a common currency.
Several factors have to be borne in mind in looking at the
uncertainty implication on the ZAR/USD exchange rate for the next two years.
First the exchange rate is endogenous variable, whose values are determined by
exogenous shocks. As such, exchange rate changes constitute one important
channel through which such exogenous development effect prices.
The source of real exchange rate movements is one of the long
debated from the monetary model through Dornbusch overshooting model to Frankel
real interest differential model till to Noise trader model. They also of
course provide information on the likely sources of movements in order
endogenous macroeconomics variables - such as consumer prices and GDP. It
useful of taking into account of this information when examining the sources of
currency movements.
II. LITTERATURE REVIEW
This section outlines the basic concepts needed to analyse the
behaviour of the ZAR/USD exchange rate. Before that, we know that the basic
arbitrage relationship's in the exchange market is based on the following
conditions:
· The Covered Interest rate Parity (CIP) and the
Uncovered Interest rate Parity (UIP). Where the CIP is expressed like:  (2.1)
f is the forward rate, s the spot rate, r the domestic rate
and r* the foreign rate. The expression (1) is an equilibrium condition based
on riskless arbitrage.
The UIP under assumption of risk neutrality is expressed
as:
  (2.2)
· The Purchasing Power Parity (PPP) which is an
equilibrium condition in the market and its view of price determination assumes
that domestic currency will be subject to arbitrage and will therefore equal
the price in domestic currency units of the foreign currency.
| 
