Abstract
Develops a method of forecasting foreign exchange rate by normal
mixture model (NMM). Initially establishes a set of exchange rate models
and switches from one model to another probabilistically, depending on
supply shocks or government policy changes. By assuming that the
population distribution of foreign exchange rate is a mixture of normal
distributions, these models can then be estimated simultaneously. Uses
the estimated parameters of the model to forecast foreign exchange rate,
and then four foreign exchange rate models are used to estimate the NMM.
The out‐of‐sample forecasting results obtained show that we can decrease
the mean squared error (MSE) of forecast error dramatically by using the
NMM, compared with the MSE of the best forecast of each separate model.
Subject
General Economics, Econometrics and Finance
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