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Can Fluctuations in the Consumption-Wealth Ratio Help to Predict Exchange Rates?

  • Jorge Selaive

    ()

    (Central Bank of Chile)

  • Vicente Tuesta R

    ()

    (Central Bank of Peru)

It is well documented that macroeconomic fundamentals are little help in predicting changes in nominal exchange rates compared to the predictions made by a simple random walk. Lettau and Ludvigson (2001) find that fluctuations in the common long-term trend in consumption, asset wealth, and labor income (hereby, consumption-wealth ratio) is a strong predictor of the excess returns. In this paper, we study the role of the consumption-wealth ratio in predicting the change in the nominal exchange rate of a large set of countries. We find evidence that fluctuations in the consumption-wealth ratio help to predict in-sample all the currencies. In terms of out-of-sample forecasts, our results suggest that the consumption-wealth ratio may play a significant role at predicting the Canadian dollar at all horizons and at short-intermediate horizons for some currencies.

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Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2005-002.

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Date of creation: Jan 2005
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Handle: RePEc:rbp:wpaper:2005-002
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