This paper compares the true, ex-ante forecasting performance of a micro-based model against both a standard macro model and a random walk. In contrast to existing literature, which is focused on longer horizon forecasting, we examine forecasting over horizons from one day to one month (the one-month horizon being where micro and macro analysis begin to overlap). Over our 3-year forecasting sample, we find that the micro-based model consistently out-performs both the random walk and the macro model. Micro-based forecasts account for almost 16 per cent of the sample variance in monthly spot rate changes. These results provide a level of empirical validation as yet unattained by other models. Our result that the micro-based model out-performs the macro model does not imply that macro fundamentals will never explain exchange rates. Quite the contrary, our findings are in fact consistent with the view that the principal driver of exchange rates is standard macro fundamentals. In Evans and Lyons (2004b)we report firm evidence that the non-public information that we exploit here for forecasting exchange rates is also useful for forecasting macro fundamentals themselves.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
11042.
Length: Date of creation: Jan 2005 Date of revision: Handle: RePEc:nbr:nberwo:11042
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Find related papers by JEL classification: F3 - International Economics - - International Finance F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance G1 - Financial Economics - - General Financial Markets
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