EFN426

Assignment 2
Spot and forward rates for USD/AUD exchange rate
DUE - Draft Sunday 25 Sep 11:59pm Final Sunday 9 Oct 11:59pm
Data description: spot.dta
date a weekly date variable from 1984w1 until 1990w6
spot USD/AUD spot exchange rate
forward3 3-month (12-week) forward USD/AUD exchange rate
NOTE: The data has already been declared as time series, using date as the time variable.
Submission: Report, max 10 pages (Word file) and .do-file
All the analysis must be replicable using your submitted do-file.

Summary
The data is weekly U.S. / Australian spot exchange rate 𝑠𝑡, and weekly observations on a 3-month forward
rate, 𝑓𝑡 .
The forward contract is a three-month contract and theory suggests that the forward rate three months
earlier, ft-12 , should be a good predictor of the current spot price 𝑠𝑡. This is the case if the forward rate is an
unbiased predictor for the future spot rate.
Task description
Section 1 – Getting started
Get start by having an overall look at the data. Investigate the order of integration of the data series
individually. Report how you do this and what you find. Recall what statistical properties are expected of the
data series used for modelling short run dynamics and for modelling long run relationship. Create required
variables. Use graphs to illustrate the proposed short run and long run relations.
Section 2 – Short run dynamics
Investigate the short run dynamics of the two series, first individually using AR models, and then together as
VAR. Report all details of your analysis. Combine your findings into a one, single equation model that
describes the short run dynamics of the spot rate.
Section 3 – Long run relationship
The efficient, frictionless markets implies a long run relationship between spot and forward rates. Investigate
whether this is supported by your data set. Recall how cointegration is defined, and how such relation is
interpreted. Also recall how the long run relationship, if found, can be combined with the short run relation
using ECM. Interpret your findings.
Report and do-file to be submitted
The report should read as a research report supported by technical analysis. The report must have no coding
(this is why you submit the do-file). If you include graphs and Stata outputs in the report, you must
specifically refer to them. It is acceptable to simply discuss, for example, the statistical test outcomes
without the related outputs as long as those outputs are clearly present in the do-file. Use commenting in
the do-file to match the content with the report.