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Exchange Rates as Exchange Rate Common Factors

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Author Info

  • Ryan Greenaway-McGrevy

    (Bureau of Economic Analysis)

  • Nelson C. Mark

    (University of Notre Dame and National Bureau of Economic Research and Hong Kong Institute for Monetary Research)

  • Donggyu Sul

    (University of Texas at Dallas)

  • Jyh-Lin Wu

    (National Sun Yat Sen University)

Abstract

Factor analysis performed on a panel of 23 nominal exchange rates from January 1999 to December 2010 yields three common factors. This paper identifies the euro/dollar, Swiss-franc/dollar and yen/dollar exchange rates as empirical counterparts to these common factors. These empirical factors explain a large proportion of exchange rate variation over time and have significant in-sample and out-of-sample predictive power.

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Bibliographic Info

Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 212012.

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Length: 29 pages
Date of creation: Aug 2012
Date of revision:
Handle: RePEc:hkm:wpaper:212012

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Keywords: Exchange Rates; Common Factors; Forecasting;

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References

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  1. Charles Engel & Nelson C. Mark & Kenneth D. West, 2008. "Exchange Rate Models Are Not As Bad As You Think," NBER Chapters, in: NBER Macroeconomics Annual 2007, Volume 22, pages 381-441 National Bureau of Economic Research, Inc.
  2. Jeffrey A. Frankel and Andrew K. Rose., 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C95-052, University of California at Berkeley.
  3. Jushan Bai, 2009. "Panel Data Models With Interactive Fixed Effects," Econometrica, Econometric Society, Econometric Society, vol. 77(4), pages 1229-1279, 07.
  4. Groen, Jan J J, 2005. "Exchange Rate Predictability and Monetary Fundamentals in a Small Multi-country Panel," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 37(3), pages 495-516, June.
  5. Kenneth D. West & Todd Clark, 2006. "Approximately Normal Tests for Equal Predictive Accuracy in Nested Models," NBER Technical Working Papers 0326, National Bureau of Economic Research, Inc.
  6. Molodtsova, Tanya & Papell, David H., 2009. "Out-of-sample exchange rate predictability with Taylor rule fundamentals," Journal of International Economics, Elsevier, Elsevier, vol. 77(2), pages 167-180, April.
  7. Nick Roussanov & Adrien Verdelhan & Hanno Lustig, 2008. "Common Risk Factors in Currency Markets," 2008 Meeting Papers 711, Society for Economic Dynamics.
  8. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, Elsevier, vol. 38(1-2), pages 161-178, February.
  9. Greenaway-McGrevy, Ryan & Han, Chirok & Sul, Donggyu, 2012. "Asymptotic distribution of factor augmented estimators for panel regression," Journal of Econometrics, Elsevier, Elsevier, vol. 169(1), pages 48-53.
  10. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, Elsevier, vol. 14(1-2), pages 3-24, February.
  11. Nelson Mark & Donggyu Sul, 1998. "Norminal Exchange Rates and Monetary Fundamentals: Evidence from a Small Post-Bretton Woods Panel," Working Papers, Ohio State University, Department of Economics 98-19, Ohio State University, Department of Economics.
  12. Barbara Rossi, 2005. "Testing Long-Horizon Predictive Ability With High Persistence, And The Meese-Rogoff Puzzle," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(1), pages 61-92, 02.
  13. Charles Engel & Nelson C. Mark & Kenneth D. West, 2012. "Factor Model Forecasts of Exchange Rates," NBER Working Papers 18382, National Bureau of Economic Research, Inc.
  14. Stock J.H. & Watson M.W., 2002. "Forecasting Using Principal Components From a Large Number of Predictors," Journal of the American Statistical Association, American Statistical Association, American Statistical Association, vol. 97, pages 1167-1179, December.
  15. Adrien Verdelhan, 2012. "The Share of Systematic Variation in Bilateral Exchange Rates," 2012 Meeting Papers, Society for Economic Dynamics 763, Society for Economic Dynamics.
  16. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(3), pages 488-509, June.
  17. Jan J. J. Groen, 1999. "Long horizon predictability of exchange rates: Is it for real?," Empirical Economics, Springer, Springer, vol. 24(3), pages 451-469.
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Citations

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Cited by:
  1. Rossi, José Luiz Júnior, 2014. "The Usefulness of Financial Variables in Predicting Exchange Rate Movements," Insper Working Papers, Insper Working Paper, Insper Instituto de Ensino e Pesquisa wpe_332, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
  2. Jose Luiz Rossi Junior & Wilson Rafael de Oliveira Felicio, 2014. "Common Factors and the Exchange Rate: Results From the Brazilian Case," Revista Brasileira de Economia, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil), vol. 68(1), pages 49-71, April.
  3. Rossi, José Luiz Júnior, 2013. "Liquidity and Exchange Rates," Insper Working Papers, Insper Working Paper, Insper Instituto de Ensino e Pesquisa wpe_325, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.

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