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Exchange Rate Predictability and Financial Conditions

Author

Listed:
  • Sebastian Fossati

    (University of Alberta)

  • Xiao Li

    (University of Alberta)

Abstract

We model the conditional distribution of future exchange rate returns for nine currencies as a function of real-time financial conditions. We show that the lower and upper quantiles of the exchange rate return distribution exhibit significant in-sample co-movement with financial conditions. Similarly, the conditional moments of the out-of-sample forecast display time-varying patterns, with the variance and kurtosis showing the most pronounced changes during and after the 2008-09 financial crisis. Deteriorating financial conditions are associated with an increase in volatility, particularly for commodity currencies. Overall, we conclude that financial conditions capture tail dependencies in exchange rate returns and contain valuable information for out-of-sample prediction.

Suggested Citation

  • Sebastian Fossati & Xiao Li, 2025. "Exchange Rate Predictability and Financial Conditions," Working Papers 2025-06, University of Alberta, Department of Economics.
    • Handle: RePEc:ris:albaec:021546
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    File URL: https://sites.ualberta.ca/~econwps/2025/wp2025-06.pdf
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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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