A Model of Currency Forecasting Based on FX Option Market's Perspective

Abstract

Traditional currency forecasting methods are mainly based on historical data and market sentiments. In this thesis a new model was developed, in which a currency's price range is predicted based on the market perspectives that could be a useful complementary viewpoint compared to the traditional ones. The objectives of this study are, firstly, forecasting the price range of EUR/USD in the month of April, and secondly, constructing a new method of foreign exchange forecasting. The view of market on the currency is represented in its option quotes. Under the log-normal distribution assumptions, two important theories used in this work are Garman Kohlhagen model, a Black-Scholes extension for foreign exchange, and Value at Risk. The model was tested during a short time frame with the currency pair of EUR and USD. It showed a very positive result with accurate prediction. Although the study pointed out some cautions and limitations when implementing this method, the model is still at an immature stage and should be tested more on different currency pairs and time periods.