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What's next for YTL/$ rate?: Let's simulate!

Tue, Apr 8 2008, 09:29 GMT
by Yapi Kredi Bank Economic Research Department

Yapi Kredi Bank

Here is the sequel to our analysis of YTL/$ released in our March 25 dated Occasional Paper “YTL/$ Responds ARCHly to Markets’ Tune”. We there tried to come up with a relevant framework within which movements of the YTL/$ could be explained both level and volatilitywise. The reason such an analysis became imposing was developments on both global and local scenes which led to significant volatility and level changes in the FX market.

Regardless of their distinct qualitative nature, all developments that are able to create disturbances can be treated as shocks to the system (i.e. markets in our case) from a quantitative point of view. Understanding, technically speaking “explaining”, the nature of exchange rate movements through properly chosen variables is (was) a worthwhile effort.

That granted, we intend to take the analysis one step further and try to conjecture some possible paths that the exchange rate might follow in the upcoming period. Instead of trying to come up with point estimates that are bound to be subject to significant forecast errors, we resort to generate alternative paths.

For short term purposes, it is more prudent to simulate viable alternative paths that are defined with respect to certain exogenous constraints which can be altered according to circumstances or forecast producer’s reading of circumstances. As will become apparent shortly, it is an extremely flexible framework given the chosen structure.

Since we will conduct a simulation analysis, we dropped the exogenous variables (i.e. cds and vix) from the mean and variance equations we previously used. We instead modify our previous model so as to take into account the nonlinearity which might be present in this kind of high frequency data.

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Published on  Tue, Apr 8 2008, 09:33 GMT