Page 97 - Special Topic Session (STS) - Volume 4

STS566 Iluminada T. Sicat
In 2018, the currency forecast model was again enhanced to add 2 more
dummy variables to adjust the impact of seasonality in cash demand observed
in Q2 and Q4, and adjustment terms to account for serial correlation.
Model 4: (2017 - present) Model 3 + dummy variable for Q2 + dummy
variable for Q4 + AR & MA terms

Where:

DFIN08 – dummy variable for financial crisis

t – error correction term

dummy variable Q2

dummy variable Q4

AR & MA terms – to account for serial correlation

5. MAPE: Evaluating Reliability of Forecasting Models
The following presents an assessment of the performance of the models
used relative to actual. The best performing model is that which produces the
lowest forecast error on average, based on the mean absolute percent error
or MAPE. MAPE refers to the variance or difference between the forecasts and
actual. Lower MAPE indicates the model’s improving goodness of fit. As can
be gleaned from the table below, MAPE has been declining from a high of
33% to 6.9%, which can indicate improving forecast performance. Similarly,
the accuracy of the forecast is even more enhanced with the introduction of
dummy variables and autoregressive terms in Model 4, yielding a MAPE of
only around 2% based on in-sample and out-samples estimates.

Model Model 1 Model 2 Model 3 Model 4
MAPE 33.3 % 12.9 % 6.9 % 2.0 %

6. Other Factors Affecting Currency Demand
In addition to economic variables, the currency demand framework is also
underpinned by the need to maintain a level of inventory for pre-cautionary
needs. In the Philippines, the BSP Monetary Board, in the past, has approved
to maintain 2 types of safety cushions called the “buffer” stock and
“contingency reserves”, equivalent each to 3 months average withdrawal for
the past 3 years. The buffer stock is meant to serve as cushion or cover
primarily against uncertainty regarding spikes in demand for cash arising from
unexpected business cycle, or uncertainty arising from timing in supply
delivery. Meanwhile, the contingency reserves are meant to provide supply in

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