Say I need to predict what the spot rate between USD and CAD will be in 3 months. What will be the most accurate measure or model that I could possibly use? Does the 3 month forward rate necessarily represent the best guess for the future rate, or is there a model or measure that consistently estimates a superior guess for the future price?


It is very difficult to outperform the "random walk without drift" benchmark. The forward rate is not a particularly good predictor as it is often biased.

Nevertheless some economists claim it is possible. Here is a literature review (Barbara Rossi: Exchange Rate Predictability, Journal of Economic Literature vol. 51, no. 4, December 2013):


From reading this it would seem that Taylor Rules and Net Foreign Assets might hold some promise. Since the CAD is a Commodity Currency, commodity prices may be worth investigating.

But it looks like a tough job.

  • $\begingroup$ That literature review is extremely helpful, thank you $\endgroup$
    – beeba
    Apr 19 '16 at 15:10

You could compare 3 month fx forward points versus realised 3 month fx differentials to see if interest rate differentials are a good predictor. I looked at a 1 year horizon and concluded that you cannot ignore the interest rate differential, but on the other hand the best prediction might lie between zero drift and the fx forward predicted rate.

  • 1
    $\begingroup$ "the best prediction might lie between zero drift and the fx forward predicted rate". I agree with this.The interest rate differential predicts a depreciation of the high interest currency which often only partially occurs, or not at all. $\endgroup$
    – Alex C
    Nov 19 '17 at 19:02

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