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Can Affine Term Structure Models Help Us Predict Exchange Rates?

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  • ANTONIO DIEZ DE LOS RIOS

Abstract

This paper proposes an arbitrage-free model to extract the information that the term structure of forward premia contains for forecasting future spot exchange rates. Using monthly data on four U.S. dollar bilateral exchange rates, we find evidence that this model provides statistically better forecasts than those produced by a random walk for the British pound and Canadian dollar exchange rates. Negative results for the German mark/Euro and Swiss franc are explained by a rejection of the restrictions imposed by the term structure model. Copyright (c) 2009 The Ohio State University.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 41 (2009)
Issue (Month): 4 (06)
Pages: 755-766

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Handle: RePEc:mcb:jmoncb:v:41:y:2009:i:4:p:755-766

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  1. Lars Peter Hansen & Robert J. Hodrick, 1983. "Risk Averse Speculation in the Forward Foreign Exchange Market: An Econometric Analysis of Linear Models," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 113-152 National Bureau of Economic Research, Inc.
  2. Clarida, Richard & Sarno, Lucio & Taylor, Mark P & Valente, Giorgio, 2002. "The Out-of-Sample Success of Term Structure Models as Exchange Rate Predictors: A Step Beyond," CEPR Discussion Papers 3281, C.E.P.R. Discussion Papers.
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  4. Hodrick, Robert & Vassalou, Maria, 2002. "Do we need multi-country models to explain exchange rate and interest rate and bond return dynamics?," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1275-1299, July.
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Cited by:
  1. Yu-chin Chen & Kwok Ping Tsang, 2010. "A Macro-Finance Approach to Exchange Rate Determination," Working Papers e07-19, Virginia Polytechnic Institute and State University, Department of Economics.
  2. Carmen Gloria Silva, 2010. "Forward premium puzzle and term structure of interest rates: the case of New Zealand," Working Papers Central Bank of Chile 570, Central Bank of Chile.
  3. Wagner, Christian, 2009. "Risk-Premia, Carry-Trade Dynamics, and Economic Value of Currency Speculation," MPRA Paper 21125, University Library of Munich, Germany.
  4. Taboga, Marco & Pericoli, Marcello, 2008. "Bond risk premia, macroeconomic fundamentals and the exchange rate," MPRA Paper 9523, University Library of Munich, Germany.
  5. Lucio Sarno & Paul Schneider & Christian Wagner, 2012. "Properties of Foreign Exchange Risk Premiums," Working Paper Series 10_12, The Rimini Centre for Economic Analysis.
  6. Kaminska, Iryna & Meldrum, Andrew & Smith, James, 2011. "A global model of international yield curves: no-arbitrage term structure approach," Bank of England working papers 419, Bank of England.
  7. Diez de los Rios, Antonio & Sentana, Enrique, 2007. "Testing Uncovered Interest Parity: A Continuous-Time Approach," CEPR Discussion Papers 6516, C.E.P.R. Discussion Papers.
  8. Gregory H. Bauer & Antonio Diez de los Rios, 2012. "An International Dynamic Term Structure Model with Economic Restrictions and Unspanned Risks," Working Papers 12-5, Bank of Canada.
  9. Sarno, Lucio & Schneider, Paul & Wagner, Christian, 2010. "Properties of Foreign Exchange Risk Premia," MPRA Paper 21302, University Library of Munich, Germany.

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