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Investing Under Model Uncertainty: Decision Based Evaluation of Exchange Rate and Interest Rate Forecasts in the US, UK and Japan

  • Anthony Garratt

    (Department of Economics, Mathematics & Statistics, Birkbeck)

  • Kevin Lee

We evaluate the forecast performance of a range of theory-based and atheoretical models explaining exchange rates and interest rates in US, UK and Japan. The decision-making environment is fully described for an investor who optimally allocates portfolio shares to domestic and foreign assets. Methods necessary to compute and use forecasts in this context are proposed, including the means of combining density forecasts to deal with model uncertainty. An out-of-sample evaluation exercise covering the 1990’s is described, comparing statistical criteria with decision-based criteria. The theory-based models are found to perform relatively well when their forecasts are judged by their economic value.

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File URL: http://www.bbk.ac.uk/ems/research/wp/PDF/BWPEF0616.pdf
File Function: First version, 2006
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Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0616.

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Date of creation: Dec 2006
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Handle: RePEc:bbk:bbkefp:0616
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