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

  • Pasquale Della Corte

    (Imperial College Business School)

  • Lucio Sarno

    (Cass Business School and CEPR)

  • Giulia Sestieri

    (Banque de France)

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.

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Article provided by MIT Press in its journal Review of Economics and Statistics.

Volume (Year): 94 (2012)
Issue (Month): 1 (February)
Pages: 100-115

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Handle: RePEc:tpr:restat:v:94:y:2012:i:1:p:100-115
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