IDEAS home Printed from https://ideas.repec.org/p/gla/glaewp/2011_17.html
   My bibliography  Save this paper

Measuring the economic significance of structural exchange rate models

Author

Listed:
  • Mario Cerrato
  • John Crosby
  • Muhammad Kaleem

Abstract

This paper examines both the in-sample and out-of-sample performance of three monetary fundamental models of exchange rates and compares their out-of-sample performance to that of a simple Random Walk model. Using a data-set consisting of five currencies at monthly frequency over the period January 1980 to December 2009 and a battery of newly developed performance measures, the paper shows that monetary models do better (in-sample and out-of- sample forecasting) than a simple Random Walk model.

Suggested Citation

  • Mario Cerrato & John Crosby & Muhammad Kaleem, 2011. "Measuring the economic significance of structural exchange rate models," Working Papers 2011_17, Business School - Economics, University of Glasgow.
    • Handle: RePEc:gla:glaewp:2011_17
    as

    Download full text from publisher

    File URL: http://www.gla.ac.uk/media/media_200683_en.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Lewis, Karen K., 1995. "Puzzles in international financial markets," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 37, pages 1913-1971, Elsevier.
    2. Clarida, Richard H. & Sarno, Lucio & Taylor, Mark P. & Valente, Giorgio, 2003. "The out-of-sample success of term structure models as exchange rate predictors: a step beyond," Journal of International Economics, Elsevier, vol. 60(1), pages 61-83, May.
    3. Aleš Černý, 2003. "Generalised Sharpe Ratios and Asset Pricing in Incomplete Markets," Review of Finance, European Finance Association, vol. 7(2), pages 191-233.
    4. Frenkel, Jacob A, 1981. "Flexible Exchange Rates, Prices, and the Role of "News": Lessons from the 1970s," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 665-705, August.
    5. Kandel, Shmuel & Stambaugh, Robert F, 1996. "On the Predictability of Stock Returns: An Asset-Allocation Perspective," Journal of Finance, American Finance Association, vol. 51(2), pages 385-424, June.
    6. Cornell, Bradford, 1977. "Spot rates, forward rates and exchange market efficiency," Journal of Financial Economics, Elsevier, vol. 5(1), pages 55-65, August.
    7. Abhyankar, Abhay & Sarno, Lucio & Valente, Giorgio, 2005. "Exchange rates and fundamentals: evidence on the economic value of predictability," Journal of International Economics, Elsevier, vol. 66(2), pages 325-348, July.
    8. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    9. Pasquale Della Corte & Lucio Sarno & Ilias Tsiakas, 2009. "An Economic Evaluation of Empirical Exchange Rate Models," The Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3491-3530, September.
    10. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
    11. Backus, David K & Gregory, Allan W & Telmer, Chris I, 1993. "Accounting for Forward Rates in Markets for Foreign Currency," Journal of Finance, American Finance Association, vol. 48(5), pages 1887-1908, December.
    12. Jonathan Ingersoll & Ivo Welch, 2007. "Portfolio Performance Manipulation and Manipulation-proof Performance Measures," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1503-1546, 2007 17.
    13. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    14. Koop,Gary & Poirier,Dale J. & Tobias,Justin L., 2007. "Bayesian Econometric Methods," Cambridge Books, Cambridge University Press, number 9780521671736, June.
    15. Richard H. Clarida & Lucio Sarno & Mark P. Taylor & Giorgio Valente, 2006. "The Role of Asymmetries and Regime Shifts in the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1193-1224, May.
    16. David K. Backus & Silverio Foresi & Chris I. Telmer, 2001. "Affine Term Structure Models and the Forward Premium Anomaly," Journal of Finance, American Finance Association, vol. 56(1), pages 279-304, February.
    17. Diebold, Francis X. & Nason, James A., 1990. "Nonparametric exchange rate prediction?," Journal of International Economics, Elsevier, vol. 28(3-4), pages 315-332, May.
    18. Chan,Joshua & Koop,Gary & Poirier,Dale J. & Tobias,Justin L., 2019. "Bayesian Econometric Methods," Cambridge Books, Cambridge University Press, number 9781108437493, January.
    19. Yufeng Han, 2006. "Asset Allocation with a High Dimensional Latent Factor Stochastic Volatility Model," The Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 237-271.
    20. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
    21. Antonio E. Bernardo & Olivier Ledoit, 2000. "Gain, Loss, and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 144-172, February.
    22. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
    23. Dilip Madan, 2010. "Pricing and hedging basket options to prespecified levels of acceptability," Quantitative Finance, Taylor & Francis Journals, vol. 10(6), pages 607-615.
    24. Alexander Cherny & Dilip Madan, 2009. "New Measures for Performance Evaluation," The Review of Financial Studies, Society for Financial Studies, vol. 22(7), pages 2371-2406, July.
    25. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Exchange rate modelling: is the random walk beatable?
      by Economic Logician in Economic Logic on 2012-01-29 20:49:00

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.
    2. Wagner, Christian, 2012. "Risk-premia, carry-trade dynamics, and economic value of currency speculation," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1195-1219.
    3. Lucio Sarno & Giorgio Valente, 2009. "Exchange Rates and Fundamentals: Footloose or Evolving Relationship?," Journal of the European Economic Association, MIT Press, vol. 7(4), pages 786-830, June.
    4. Della Corte, Pasquale & Sarno, Lucio & Tsiakas, Ilias, 2011. "Spot and forward volatility in foreign exchange," Journal of Financial Economics, Elsevier, vol. 100(3), pages 496-513, June.
    5. Barbara Rossi, 2013. "Exchange Rate Predictability," Journal of Economic Literature, American Economic Association, vol. 51(4), pages 1063-1119, December.
    6. Ahmed, Shamim & Liu, Xiaoquan & Valente, Giorgio, 2016. "Can currency-based risk factors help forecast exchange rates?," International Journal of Forecasting, Elsevier, vol. 32(1), pages 75-97.
    7. Lucio Sarno, 2005. "Viewpoint: Towards a solution to the puzzles in exchange rate economics: where do we stand?," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 38(3), pages 673-708, August.
    8. Christian Wagner, 2008. "Risk-Premia, Carry-Trade Dynamics, and Speculative Efficiency of Currency Markets," Working Papers 143, Oesterreichische Nationalbank (Austrian Central Bank).
    9. Karen K. Lewis, 2011. "Global Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 435-466, December.
    10. Philippe Bacchetta & Eric van Wincoop, 2005. "Rational Inattention: A Solution to the Forward Discount Puzzle," FAME Research Paper Series rp156, International Center for Financial Asset Management and Engineering.
    11. Sarno, Lucio & Schneider, Paul & Wagner, Christian, 2012. "Properties of foreign exchange risk premiums," Journal of Financial Economics, Elsevier, vol. 105(2), pages 279-310.
    12. Gianna Boero & Emanuela Marrocu, 2005. "Evaluating non-linear models on point and interval forecasts: an application with exchange rates," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 58(232), pages 91-120.
    13. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    14. Engel, Charles, 2014. "Exchange Rates and Interest Parity," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 453-522, Elsevier.
    15. Bond, Derek & Harrison, Michael J & Hession, Niall & O’Brien, Edward J., 2006. "Some Empirical Observations on the Forward Exchange Rate Anomaly," Research Technical Papers 3/RT/06, Central Bank of Ireland.
    16. Bali, Turan G. & Wu, Liuren, 2010. "The role of exchange rates in intertemporal risk-return relations," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1670-1686, December.
    17. Tai, Chu-Sheng, 1999. "Time-varying risk premia in foreign exchange and equity markets: evidence from Asia-Pacific countries," Journal of Multinational Financial Management, Elsevier, vol. 9(3-4), pages 291-316, November.
    18. Newbold, Paul & Wohar, Mark E. & Rayner, Tony & Kellard, Neil & Ennew, Christine, 1998. "Two puzzles in the analysis of foreign exchange market efficiency," International Review of Financial Analysis, Elsevier, vol. 7(2), pages 95-111.
    19. Medel, Carlos & Camilleri, Gilmour & Hsu, Hsiang-Ling & Kania, Stefan & Touloumtzoglou, Miltiadis, 2015. "Robustness in Foreign Exchange Rate Forecasting Models: Economics-based Modelling After the Financial Crisis," MPRA Paper 65290, University Library of Munich, Germany.
    20. Della Corte, Pasquale & Sarno, Lucio & Valente, Giorgio, 2010. "A century of equity premium predictability and the consumption-wealth ratio: An international perspective," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 313-331, June.

    More about this item

    Keywords

    monetary models; forecasting;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

    NEP fields

    This paper has been announced in the following NEP Reports:

    Lists

    This item is featured on the following reading lists, Wikipedia, or ReplicationWiki pages:
    1. Economic Logic blog

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gla:glaewp:2011_17. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Business School Research Team (email available below). General contact details of provider: https://edirc.repec.org/data/dpglauk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.