Probability Distribution of Forecasts. Assume that the following regression model was applied to historical quarterly data: e
Question:
Probability Distribution of Forecasts. Assume that the following regression model was applied to historical quarterly data:
ef,t = a0 + a1INTt + a2INFt-1 + t
where ef,t = percentage change in the JPYUSD exchange rate in period t
INTt = interest rate differential between U.S. and Japan (iUS-iJAP) over period t
INFt-1 = inflation differential between U.S. and Japan (iUS-iJAP) in the previous period
a0, a1, a2 = regression coefficients
t = error term
Assume that the regression coefficients were estimated as follows:
a0 = 0.0, a1 = 0.85, a2 = 0.7
Also, assume that the inflation differential in the most recent period was 2%. The real interest rate differential in the upcoming period is forecasted as follows:
(iUS-iJAP) Probability
0% 20%
1 50%
2 30%
If Caterpillar Corp. uses this information to forecast the Japanese yen's exchange rate, what will be the probability distribution of the yen's percentage change over the upcoming period?
Expert Answer:
