This is almost certainly going to make me seem like a novice, but googling for answers is very difficult for this sort of thing.

My friend asked me to take a look at some forex data recently. My instincts for vector-valued time series are to plot some pictures and try models. If I have to pre-process the data, I generally know what's acceptable.

This is my question: is it more interpretable to convert everything into the base currency? Is this commonly done?

Say we have four countries: A,B, C and D, and I'm from country C. Say we have available at some time $(\frac{A}{D}, \frac{A}{C},\frac{B}{C})$.

Instead of modelling $(\frac{A}{D}, \frac{A}{C},\frac{B}{C})$ directly shouldn't we model $(\frac{A}{C},\frac{B}{C},\frac{D}{C})$? Here $\frac{D}{C} = \frac{A}{C}/\frac{A}{D}$.

Now everything is in the same units, and this also facilitates profit calculations. Or does all of this depend on the models I'm using? Is it more common to model these levels, or their changes? Or maybe even their returns?

  • $\begingroup$ Generally yes. For econometric studies involving currencies it is best to put them on a common basis such as you suggest, even though in the FX markets conventions differ depending on the currency (sometimes 1 unit of the foreign currency is priced in dollars and sometimes the dollar is priced in the foreign). If nothing else it makes it less confusing to work with (and entirely analogous to the price of apples, potatoes, etc). But don't try to convince FX traders to do things this way, they are completely used to their method. $\endgroup$ – Alex C Aug 29 '16 at 5:36
  • $\begingroup$ What is their method? $\endgroup$ – Taylor Aug 29 '16 at 5:51

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