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Forecasting exchange rate using Variational Mode Decomposition and entropy theory

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  • He, Kaijian
  • Chen, Yanhui
  • Tso, Geoffrey K.F.

Abstract

In this paper, we propose a new exchange rate forecasting model using Variational Mode Decomposition (VMD) with parameter optimization by the combined Mean Square Error (MSE) and Error Entropy (EE) criterion. Exchange rate is decomposed into a series of underlying data components in the transformed multiscale domain using the VMD model. A new MSE–EE criterion is proposed to determine the scale for transient factors among different extracted data components. The proposed model extracts the transient factor more accurately and produces more accurate forecasts. Empirical studies using extensive exchange rates confirmed that the multiscale data structure can be identified more effectively in the decomposed multiscale domain using the proposed methodology. The proposed model demonstrates the superior performance compared to the benchmark models.

Suggested Citation

  • He, Kaijian & Chen, Yanhui & Tso, Geoffrey K.F., 2018. "Forecasting exchange rate using Variational Mode Decomposition and entropy theory," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 510(C), pages 15-25.
    • Handle: RePEc:eee:phsmap:v:510:y:2018:i:c:p:15-25
    DOI: 10.1016/j.physa.2018.05.135
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    2. Matthieu Garcin, 2019. "Hurst Exponents And Delampertized Fractional Brownian Motions," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(05), pages 1-26, August.
    3. Zhang, Yagang & Zhao, Yunpeng & Shen, Xiaoyu & Zhang, Jinghui, 2022. "A comprehensive wind speed prediction system based on Monte Carlo and artificial intelligence algorithms," Applied Energy, Elsevier, vol. 305(C).
    4. He, Kaijian & Tso, Geoffrey K.F. & Zou, Yingchao & Liu, Jia, 2018. "Crude oil risk forecasting: New evidence from multiscale analysis approach," Energy Economics, Elsevier, vol. 76(C), pages 574-583.
    5. Zhu, Jiaming & Wu, Peng & Chen, Huayou & Liu, Jinpei & Zhou, Ligang, 2019. "Carbon price forecasting with variational mode decomposition and optimal combined model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 519(C), pages 140-158.
    6. Zhu, Bangzhu & Yuan, Lili & Ye, Shunxin, 2019. "Examining the multi-timescales of European carbon market with grey relational analysis and empirical mode decomposition," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 517(C), pages 392-399.
    7. Matthieu Garcin, 2018. "Hurst exponents and delampertized fractional Brownian motions," Working Papers hal-01919754, HAL.
    8. Wang, Xiangning & Huang, Qian & Zhang, Shuguang, 2023. "Effects of macroeconomic factors on stock prices for BRICS using the variational mode decomposition and quantile method," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).

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    More about this item

    Keywords

    Variational Mode Decomposition; Exchange rate forecasting; Multi-scale analysis; Minimum error entropy; Transient factor; Signal processing;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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