Factor Model Forecasts of Exchange Rates
AbstractWe construct factors from a cross section of exchange rates and use the idiosyncratic deviations from the factors to forecast. In a stylized data generating process, we show that such forecasts can be effective even if there is essentially no serial correlation in the univariate exchange rate processes. We apply the technique to a panel of bilateral U.S. dollar rates against 17 OECD countries. We forecast using factors, and using factors combined with any of fundamentals suggested by Taylor rule, monetary and purchasing power parity (PPP) models. For long horizon (8 and 12 quarter) forecasts, we tend to improve on the forecast of a “no change” benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18382.
Date of creation: Sep 2012
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Find related papers by JEL classification:
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
- F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
- G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-22 (All new papers)
- NEP-CBA-2012-09-22 (Central Banking)
- NEP-FOR-2012-09-22 (Forecasting)
- NEP-MON-2012-09-22 (Monetary Economics)
- NEP-OPM-2012-09-22 (Open Economy Macroeconomic)
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- Ryan Greenaway-McGrevy & Nelson C. Mark & Donggyu Sul & Jyh-Lin Wu, 2012. "Exchange Rates as Exchange Rate Common Factors," Working Papers 212012, Hong Kong Institute for Monetary Research.
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