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Investing Under Model Uncertainty: Decision Based Evaluation of Exchange Rate and Interest Rate Forecasts in the US, UK and Japan

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  • Anthony Garratt

    (Department of Economics, Mathematics & Statistics, Birkbeck)

  • Kevin Lee

Abstract

We evaluate the forecast performance of a range of theory-based and atheoretical models explaining exchange rates and interest rates in US, UK and Japan. The decision-making environment is fully described for an investor who optimally allocates portfolio shares to domestic and foreign assets. Methods necessary to compute and use forecasts in this context are proposed, including the means of combining density forecasts to deal with model uncertainty. An out-of-sample evaluation exercise covering the 1990’s is described, comparing statistical criteria with decision-based criteria. The theory-based models are found to perform relatively well when their forecasts are judged by their economic value.

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File URL: http://www.bbk.ac.uk/ems/research/wp/PDF/BWPEF0616.pdf
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Bibliographic Info

Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0616.

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Date of creation: Dec 2006
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Handle: RePEc:bbk:bbkefp:0616

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Keywords: Model Averaging; Buy and Hold; Exchange rate and interest rate forecasts.;

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  1. Nelson Mark & Donggyu Sul, 1998. "Norminal Exchange Rates and Monetary Fundamentals: Evidence from a Small Post-Bretton Woods Panel," Working Papers 98-19, Ohio State University, Department of Economics.
  2. Yin-Wong Cheung & Antonio Garcia Pascual & Menzie David Chinn, 2004. "Empirical Exchange Rate Models of the Nineties," IMF Working Papers 04/73, International Monetary Fund.
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  7. Richard H. Clarida & Mark P. Taylor, 1997. "The Term Structure Of Forward Exchange Premiums And The Forecastability Of Spot Exchange Rates: Correcting The Errors," The Review of Economics and Statistics, MIT Press, vol. 79(3), pages 353-361, August.
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Cited by:
  1. Kevin Lee & Anthony Garratt & Kalvinder Shields, 2009. "Decision Making in hard Times: What is a Recession, Why Do We Care and How Do We Know When We Are in One?," Discussion Papers in Economics 09/22, Department of Economics, University of Leicester.

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