Predictions & Exchange Rate Dynamics

The purpose of this study is to explore the behavior of exchange rates in five SARRC economies; namely Pakistan, India, Nepal, Bangladesh and Sri Lanka. Link between macroeconomic fundamentals and exchange rates has been investigated using ordinary least square method to test the explanation power of predictors, to explore the integration Johansen’s co-integration test has been implied and granger causality test has been used to test the casual relationship. However, regression analysis proves that economic variables are not senseless, whereas Johansen co-integration technique affirm the existence of long run relationship between exchange rate and macro-economic variables. Vector Error Correction Mechanism has been applied to gauge the speed of adjustment in relationship between exchange rate and macroeconomic fundamentals. Thus Pakistan and Sri Lanka aid the transmission channel of portfolio balance approach in the short run, while India supports the transmission channel of traditional approach toward relationship between macroeconomic variables and currency market. Though, in macroeconomic variables and currency exchange rates a feedback relationship has been measured, while analyzing Nepal and Bangladesh. This empirical research specifies that in scheming of exchange rate policies, causation must be a compulsory constituent. Then the relation of macroeconomic variables and exchange rates should also be considered by risk management process. The result of this research suggests that in long run these macroeconomic variables are controlled by the policy recommendations given by the regulators, but the instability of exchange rate is hard to be restricted or controlled by these macroeconomic variables policies. Introduction Contemporary trends of emergence of new capital and financial markets, adoption of flexible exchange rates approaches, the relaxation of foreign capital and concentration of foreign investors grasp the intension of practitioners and academician researchers to study the Dynamic of foreign exchange rates and fundamental economic variables. The gradual eradication of foreign exchange controls in under developing economies has extended the opportunities for portfolio diversifications in international financial and capital markets. At the same time, under developed economies opted for flexible exchange rates approaches in late 1990’s and in early 20th century boosted the volatility in foreign exchange rates and the risk associated with foreign exchange markets. Currency denomination preferences have added the crucial facet to the overall portfolio decisions. This study investigates the dynamic of currency exchange rates and macroeconomic variables, underpinning economic determinants of nominal exchange rates while predictive capacity of exchange rate models in five SAARC economies. These are Pakistan, Bangladesh, India, Sri-Lanka and Nepal. Are economic fundamental concepts based styles of currency trading costs strong enough to defeat a simple and naïve autoregressive exclusive shift design or not? A variety of studies have shown that risky activities in average currency trading costs are apparently confusing by macroeconomic factors alone. Models according to macroeconomic fundamental concepts, have almost never forecast come back quantity and now experts are moving towards exclusive shift styles. “Whether fundamentalists or chartist can better describe come back quantity movement” is a question, which is still unresponded to in the materials of worldwide finance. In this study, in the sample forecasting overall performance of four different styles has been compared to that of traditional standard exclusive shift design (RWM) of comeback quantity. These styles contain three economical models; namely Purchasing power parity (PPP), Interest rate parity (IRP), adhoc design and one additional design i.e. autoregressive included going frequent (ARIMA) design. The objectives of this study are: Practical Objectives:  Understanding the dynamic linkages between currency exchange rates and macroeconomic variables, this understanding will also facilitates the national as well as multinational organizations to manage their foreign exchange exposure?  Portfolio investors can use this information in to order hedge or speculate their returns on foreign investments.