Linear relationship between the AUD/USD exchange rate and the respective stock market indices: A computational finance perspective

In the recent era, computational intelligence techniques have found an increased popularity in addressing varied financial issues, including foreign exchange rate prediction. This article, through an intelligent system research framework, relates the Australian dollar (AUD)/US dollar (USD) exchange rate to the Australian and the US stock market indices. Information for exchange rate, All Ordinaries Index (AOI) and Dow Jones Industrial Average (DJI) for the trading days over the period January 1991-May 2011 is considered in this research. Utilizing a set of statistical and computational intelligence techniques, the research establishes that the AUD/USD exchange rate is best estimated by a linear forecast model compared with the nonlinear and ensemble-based intelligent system models. This research further highlights that, among the competing linear models, the model with both the stock market indices and historical exchange rate values as the predictors is the best forecaster. Parameters of the linear model are deduced through a Monte Carlo stochastic approach. Relative importance of the predictors is also studied, and the influence of historical exchange rates, the immediate impact of AOI and the lagged effect of DJI are noted.