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The Predictive Information Content of External Imbalances for Exchange Rate Returns: How Much Is It Worth?

Author

Listed:
  • Pasquale Della Corte

    (Imperial College Business School)

  • Lucio Sarno

    (Cass Business School and CEPR)

  • Giulia Sestieri

    (Banque de France)

Abstract

This paper examines the exchange rate predictability stemming from the equilibrium model of international financial adjustment developed by Gourinchas and Rey (2007). Using predictive variables that measure cyclical external imbalances for country pairs, we assess the ability of this model to forecast out-of-sample four major U.S. dollar exchange rates using various economic criteria of model evaluation. The analysis shows that the model provides economic value to a risk-averse investor, delivering substantial utility gains when switching from a portfolio strategy based on the random walk benchmark to one that conditions on cyclical external imbalances. © 2011 The President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Suggested Citation

  • Pasquale Della Corte & Lucio Sarno & Giulia Sestieri, 2012. "The Predictive Information Content of External Imbalances for Exchange Rate Returns: How Much Is It Worth?," The Review of Economics and Statistics, MIT Press, vol. 94(1), pages 100-115, February.
    • Handle: RePEc:tpr:restat:v:94:y:2012:i:1:p:100-115
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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