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Contents
Abstract 1
1. Introduction 3
2. Literature Review 3
3. Methodology 5
3.1. Identification of Currencies and Variables 5
3.2. Testing for Unit Root and Cointegration 6
3.3. Estimating and Testing the Exchange Rate Model 7
3.4. Generating In-Sample Forecasts 7
3.5. Calculating Measures of Risk and Return 10
3.5.1. Measures of risk 10
3.5.2. Measures of risk-adjusted return 11
3.6. Comparison: Carry Trade and Forecasting Based Trading 12
4. Data and Empirical Results 12
4.1. Data, Variables and Specifications 12
4.2. The results of the Unit Root Testing 17
4.3. Results of Conintegration Testing for PPP and UIP 24
4.4. Estimation and Testing the Exchange Rate Model 25
4.4. Generating In-Sample Forecasts 27
4.5. Calculating the Rates of Return of the Trading Strategies 29
4.5. Calculating Measures of Risk and Return 32
5. Conclusion 32
References 33
Appendices 35
Appendix 1 – Raw data 35
Appendix 2 – Excel Calculation for Forecasting 36
Appendix 3 –Trading Spreadsheet Sample 36
Appendix 4 – EViews Calcultion for Unit Root and Co-integration 38
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