Forgotten effects in exchange rate forecasting models

Abstract

The aim of the chapter is to identify with the methodology of forgotten effects, hidden variables that influence the behavior of the forward exchange rate US dollar/Mexican peso (USD/MXN) to then incorporate them into a structured model from the postulates of the theory of Purchasing Power Parity (PPP) and, thus, reduce forecast error. The research question that causes the problem is: Is it possible to decrease the prediction error of the PPP model, using the methodology of the forgotten effects to detect and include hidden or forgotten variables? Among the results it was found that the inclusion of hidden or forgotten variables in the PPP model, decreases forecast error for exchange rate USD/MXN in 2015.