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Factor Model Forecasts of Exchange Rates

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Author Info

  • Nelson Mark

    ()
    (Department of Economics, University of Notre Dame)

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    Abstract

    We 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 ³no change² benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.

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    File URL: http://www3.nd.edu/~tjohns20/RePEc/deendus/wpaper/012_rates.pdf
    File Function: First version, 2012
    Download Restriction: no

    Bibliographic Info

    Paper provided by University of Notre Dame, Department of Economics in its series Working Papers with number 012.

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    Length: 31 pages
    Date of creation: Nov 2008
    Date of revision: Jan 2012
    Handle: RePEc:nod:wpaper:012

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    Postal: 434 Flanner Hall, Notre Dame, IN 46556
    Phone: (574) 631-7698
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    Web page: http://economics.nd.edu
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    Related research

    Keywords: Exchange Rates; Factor Models; Forecasting;

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    Cited by:
    1. 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.
    2. West, Kenneth D. & Wong, Ka-Fu, 2014. "A factor model for co-movements of commodity prices," Journal of International Money and Finance, Elsevier, vol. 42(C), pages 289-309.
    3. Wagner Piazza Gaglianone & Jaqueline Terra Moura Marins, 2014. "Risk Assessment of the Brazilian FX Rate," Working Papers Series 344, Central Bank of Brazil, Research Department.

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