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The Predictive Information Content of External Imbalances for Exchange Rate Returns: How Much Is It Worth?

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  • Della Corte, P.
  • Sarno, L.
  • Sestieri, G.

Abstract

This paper examines the exchange rate predictability stemming from the equilibrium model of international financial adjustment developed by Gourinchas and Rey (2007). Using predictive variables that measure cyclical external imbalances for country pairs, we assess the ability of this model to forecast out-of-sample four major US dollar exchange rates using various economic criteria of model evaluation. The analysis shows that the model provides economic value to a risk-averse investor, delivering substantial utility gains when switching from a portfolio strategy based on the random walk benchmark to one that conditions on cyclical external imbalances.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 313.

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Length: 41 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bfr:banfra:313

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Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/
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Keywords: foreign exchange; predictability; global imbalances; fundamentals.;

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References

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Citations

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Cited by:
  1. Nicolas Coeurdacier & Hélène Rey, 2011. "Home Bias in Open Economy Financial Macroeconomics," NBER Working Papers 17691, National Bureau of Economic Research, Inc.
  2. Garratt, Anthony & Mise, Emi, 2014. "Forecasting exchange rates using panel model and model averaging," Economic Modelling, Elsevier, vol. 37(C), pages 32-40.
  3. Bussière, M., 2013. "In Defense of Early Warning Signals," Working papers 420, Banque de France.
  4. Barbara Rossi, 2013. "Exchange Rate Predictability," Working Papers 690, Barcelona Graduate School of Economics.

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