An upgrade of the models used to forecast the distribution of the exchange rate

19/01/2010 |  Nathan Daniel
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The Foreign Exchange Market
Abstract
The Bank of Israel uses two models, one parametric and one non-parametric, to construct a distribution function for the future shekel/dollar exchange rate. The construction of the distribution is based on theoretical developments as described in the literature, adjusted to the market for forex options traded on the Israeli stock exchange. To calibrate the models, the Bank of Israel uses option prices sampled from the order book during the day.
The purpose of this study is to propose a method for filtering out abnormal observations that arise due to the relatively low level of trade in a considerable share of options at the various strike prices using a filter based on the arbitrage rules found in the literature. The method improved the stability of both models in comparison to the filtering methods currently used at the Bank of Israel.
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