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Yield Curve Predictors of Foreign Exchange Returns ∗
, 2010
"... uncovered interest rate parity We thank Rudy LooKung for some research assistance work. We especially thank Bob Hodrick ..."
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uncovered interest rate parity We thank Rudy LooKung for some research assistance work. We especially thank Bob Hodrick
The Taylor rule and forecast intervals for exchange rates,
 Journal of Money, Credit and Banking,
, 2012
"... In this paper, we examine the MeeseRogoff puzzle from a different perspective: outofsample interval forecasting. While most studies in the literature focus on point forecasts, we apply semiparametric interval forecasting to a group of exchange rate models. Forecast intervals for 10 OECD exchange ..."
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In this paper, we examine the MeeseRogoff puzzle from a different perspective: outofsample interval forecasting. While most studies in the literature focus on point forecasts, we apply semiparametric interval forecasting to a group of exchange rate models. Forecast intervals for 10 OECD exchange rates are generated and the performance of the empirical exchange rate models are compared with the random walk. Our contribution is twofold. First, we find that in general, exchange rate models generate tighter forecast intervals than the random walk, given that their intervals cover outofsample exchange rate realizations equally well. Our results suggest a connection between exchange rates and economic fundamentals: economic variables contain information useful in forecasting distributions of exchange rates. We also find that the benchmark Taylor rule model performs better than the monetary, PPP and forward premium models, and its advantages are more pronounced at longer horizons. Second, the bootstrap inference framework proposed in this paper for forecast interval evaluation can be applied in a broader context, such as inflation forecasting. JEL codes: C14, C53, F31 Keywords: MeeseRogoff puzzle, exchange rate forecast, interval forecasting, Taylor rule model. IN A SEMINAL PAPER, We are grateful to Editor Ken West and two anonymous referees for valuable comments and suggestions that greatly improved the paper. We also thank
Currency Carry Trades ∗
, 2010
"... A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in comb ..."
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A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and outofsample. The holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorably Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of socalled risk factors. • Keywords: uncovered interest parity, exchange rates, correct classification frontier.
Exchange Rate Predictability
, 2013
"... The main goal of this article is to provide an answer to the question: “Does anything forecast exchange rates, and if so, which variables?”. It is well known that exchange rate fluctuations are very difficult to predict using economic models, and that a random walk forecasts exchange rates better th ..."
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The main goal of this article is to provide an answer to the question: “Does anything forecast exchange rates, and if so, which variables?”. It is well known that exchange rate fluctuations are very difficult to predict using economic models, and that a random walk forecasts exchange rates better than any economic model (the Meese and Rogoff puzzle). However, the recent literature has identified a series of fundamentals/methodologies that claim to have resolved the puzzle. This article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an uptodate, thorough empirical analysis. Overall, our analysis of the literature and the data suggests that the answer to the question: "Are exchange rates predictable?" is, "It depends" –on the choice of predictor, forecast horizon, sample period, model, and forecast evaluation method. Predictability is most apparent when one or more of the following hold: the predictors are Taylor rule or net foreign assets, the model is linear, and a small number of parameters are estimated. The toughest benchmark is the random walk without drift.
credit, including © notice, is given to the source. Countercyclical Currency Risk Premia
, 2010
"... The authors thank seminar participants at many institutions and conferences for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment pu ..."
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The authors thank seminar participants at many institutions and conferences for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
FORECASTING DISCONNECTED EXCHANGE RATES
"... SUMMARY The inability of empirical models to forecast exchange rates has given rise to the belief that exchange rates are disconnected from macroeconomic fundamentals. This paper addresses the potential disconnect by endogenously selecting forecast models from a broad set of fundamentals. The proce ..."
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SUMMARY The inability of empirical models to forecast exchange rates has given rise to the belief that exchange rates are disconnected from macroeconomic fundamentals. This paper addresses the potential disconnect by endogenously selecting forecast models from a broad set of fundamentals. The procedure shows that exchange rates are not disconnected from fundamentals, but fundamentals vary in their predictive content at different forecast horizons and for different currencies. Performing model selection outofsample is challenging. At short horizons, the method cannot outperform a random walk, although the performance is improved at long horizons. These findings are confirmed across currencies and forecast evaluation methods.
Federal Reserve Bank of Dallas
, 2009
"... Engel and West (EW, 2005) argue that as the discount factor gets closer to one, presentvalue asset pricing models place greater weight on future fundamentals. Consequently, current fundamentals have very weak forecasting power and asset prices in these models appear to follow approximately a random ..."
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Engel and West (EW, 2005) argue that as the discount factor gets closer to one, presentvalue asset pricing models place greater weight on future fundamentals. Consequently, current fundamentals have very weak forecasting power and asset prices in these models appear to follow approximately a random walk. We connect the EngelWest explanation to the studies of longhorizon regressions. As expected, we find that under EW’s assumption that fundamentals are I(1) and observable to the econometrician, longhorizon regressions generally do not have significant forecasting power when the discount factor is large. However, when EW’s assumptions are violated in a particular way, our analytical and simulation results show that longhorizon regressions can have substantial power, even when the discount factor is close to one and the power of shorthorizon regressions is low. One example for the substantial power improvement at long horizons is the existence of unobservable stationary fundamentals, such as the risk premium, in presentvalue asset pricing models. Consistent with our model’s prediction, we find that the risk premium calculated from survey data can forecast exchange rates at long horizons. These results
A theoretical foundation for the Nelson and Siegel class of yield curve models
, 2011
"... Yield curve models within the Nelson and Siegel (1987, hereafter NS) class have proven very popular in …nance and macro…nance, but they lack a theoretical foundation. In this article, I show how the Level, Slope, and Curvature components common to all NS models arise explicitly from loworder Taylor ..."
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Yield curve models within the Nelson and Siegel (1987, hereafter NS) class have proven very popular in …nance and macro…nance, but they lack a theoretical foundation. In this article, I show how the Level, Slope, and Curvature components common to all NS models arise explicitly from loworder Taylor expansions around central measures of the eigenvalues for the generic Gaussian a ¢ ne term structure model outlined in Dai and Singleton (2002). That theoretical foundation provides an assurance that NS models correspond to a wellaccepted framework for yield curve modeling. It further suggests that any yield curve from the GATSM class can be represented parsimoniously by a twofactor arbitragefree NS model. I derive such a model and apply it to investigating changes in United States yield curve dynamics over the period from 1971 to 2010. The results provide evidence for material changes in the datagenerating process for the yield curve between the periods 19711987, 19882002, and 20032010.
Chapter Title: Currency Carry Trades
, 2010
"... this broadly accepted puzzle, a number of metrics have been used to evaluate the predictability and profitability of exchange rate forecasts, sought to account for the possibility of timevarying risk premia—but they must then navigate between the inevitably circular reasoning that ex post risk prem ..."
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this broadly accepted puzzle, a number of metrics have been used to evaluate the predictability and profitability of exchange rate forecasts, sought to account for the possibility of timevarying risk premia—but they must then navigate between the inevitably circular reasoning that ex post risk premia could be found that in principle explain any ex post returns observed and the problem that observable socalled risk factorsand the results have by no means created consensus. Researchers have asked whether such forecasting power delivers statistically significant fit relative to random walk and if the forecast can generate economically significant profits for a riskneutral investor after transaction costs (Meese and Rogoff 1983; Kilian and Taylor 2003). Researchers have also8