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

  • Jorge Selaive

    (Central Bank of Chile)

  • Vicente Tuesta

    (New york University & Central Bank of Perú)

It is well documented that macroeconomic fundamentals are little help in predicting changes in the nominal exchange rates compared to the predictions made by a simple random walk. Letta and Ludvigson (2001) find that fluctuations in the common long-term trend in consumption, asset wealth, and labor income (herby, 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 predicting the Canadian dollar at all horizons and at short-intermediate horizons for some currencies.

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Paper provided by EconWPA in its series International Finance with number 0404014.

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Length: 21 pages
Date of creation: 26 Apr 2004
Date of revision:
Handle: RePEc:wpa:wuwpif:0404014
Note: Type of Document - pdf; pages: 21
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