MODELING AND FORECASTING EXCHANGE RATE VOLATILITY IN EEC COUNTRIES

Abstract

This main objective of this paper is to examine the properties of the GARCHmodel and its usefulness in modeling and forecasting the volatility of exchange ratemovements in selected EEC countries (Romania, Hungary and Serbia). The dailyreturns of exchange rates on Hungarian forint (HUF), Romanian lei (ROL) andSerbian dinar (RSD), all against the US dollar are analyzed during the period 03.January 2000 to 15. April 2013 in respect. In order to measure the involved risk,symmetric and asymmetric GARCH models are applied. The accuracy of exchangerate volatility forecast is evaluated through reference to the most commonly usedcriteria. These include a Mincer-Zarnowitz regression based test, Mean AbsoluteError (MAE), Root Mean Square Error (RMSE) and Diebold and Mariano test (DMtest). The results of Mincer-Zarnowitz regression test for selected exchange ratereturn series showed a clear lack of explanotory power and sub-optimality of theTGARCH model. The results of the Mean Absolute Error (MAE) and the Root MeanSquare Error (RMSE) for the forecasted volatility showed that symmetric modelbetter predict conditional variance of the exchange rate returns, but estimating resultsindicating that the parameters of forecasts are not satisfactory, i.e. models have littlepredictive power. Results for Diebold-Mariano test results for Diebold-Mariano testshowed that symmetric model outperforming TGRACH forecast in case of Hungarianforint and Serbian dinar sample series, and that only in case of Romania lei TGARCHoutperforming the GARCH forecast.