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Outperforming the naïve Random Walk forecast of foreign exchange daily closing prices using Variance Gamma and normal inverse Gaussian Levy processes

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  • Teneng, Dean

Abstract

This work demonstrates that forecast of foreign exchange (FX) daily closing prices using the normal inverse Gaussian (NIG) and Variance Gamma (VG) Levy processes outperform the naïve Random Walk model. We use the open software R to estimate NIG and VG distribution parameters and perform several classical goodness–of -fits test to select best models. Seven currency pairs can be forecasted by both Levy processes: TND/GBP, EGP/EUR, EUR/GBP, EUR/JPY, JOD/JPY, USD/GBP, and XAU/USD, while USD/JPY and QAR/JPY can be forecasted with the VG process only. RMSE values show that NIG and VG forecast are comparable, and both outperform the naïve Random Walk out of sample. Appended R-codes are original.

Suggested Citation

  • Teneng, Dean, 2013. "Outperforming the naïve Random Walk forecast of foreign exchange daily closing prices using Variance Gamma and normal inverse Gaussian Levy processes," MPRA Paper 47851, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:47851
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    References listed on IDEAS

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    1. Martin D. D. Evans & Richard K. Lyons, 2017. "Meese-Rogoff Redux: Micro-Based Exchange-Rate Forecasting," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 11, pages 457-475, World Scientific Publishing Co. Pte. Ltd..
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    JEL classification:

    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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