Question
Assume that the following regression model was applied to historical quarterly data: e t = a 0 + a 1 INT t + a 2
Assume that the following regression model was applied to historical quarterly data:
et = a0 + a1INTt + a2INFt + t
where et = percentage change in the exchange rate of the Japanese yen in period t
INTt = average real interest rate differential (U.S. interest rate - Japanese interest rate) over period t
INFt = inflation differential (U.S. inflation rate - Japanese inflation rate) in period t
a0, a1, a2 = regression coefficients
t = error term
Thus, the estimated regression equation is as follows:
^
et = 0.001 + 0.90 INTt + 0.80 INFt R2 = 0.85
(0.02) (0.30)
Please answer the questions below.
a. If the real interest rate differential was 2%, predict the change in the exchange rate. Which assumption are you making
b. If the inflation differential was 1%, predict the change in the exchange rate. Which assumption are you making?
c. If the real interest and inflation rate differentials were 1% and 2% respectively, predict the change in the exchange rate
d. What is the meaning of the R-squared?
e. Finally, determine which regression coefficients are statistically significant
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