Forecasting exchange rates of major currencies with long maturity forward rates

Zsolt Darvas and Zoltán Schepp

Corvinus Economics Working Papers (CEWP) from Corvinus University of Budapest

Abstract: This paper presents unprecedented exchange rate forecasting results based upon a new model which approximates the gap between the fundamental equilibrium exchange rate and the actual exchange rate with the long-maturity forward exchange rate. The theoretical derivation of our forecasting equation is consistent with the monetary model of exchange rates. Our model outperforms the random walk in out-of-sample forecasting of twelve major currency pairs in both short and long horizons forecasts for the 1990-2020 period. The results are robust for all sub-periods with the exception of years around the collapse of Lehman Brothers in September 2008. Our results are robust to alternative model specifications, single equation and panel estimation, recursive and rolling estimation, and alternate data construction methods. The model performs better when the long-maturity forward exchange rate is assumed to be stationary as opposed to assuming non-stationarity. The improvement in forecast accuracy of our model is economically and statistically significant for almost all exchange rate series. The model is simple, linear, easy to replicate, and the data we use are available in real time and not subject to revisions.

Keywords: exchange rate; error correction; forecasting performance; monetary model; out-of-sample; random walk (search for similar items in EconPapers)
JEL-codes: F31 F37 (search for similar items in EconPapers)
Date: 2020-03-30
New Economics Papers: this item is included in nep-for, nep-mon and nep-ore
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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https://unipub.lib.uni-corvinus.hu/5665/ original version (application/pdf)

Related works:
Working Paper: Forecasting exchange rates of major currencies with long maturity forward rates (2020)
Working Paper: Forecasting Exchange Rates of Major Currencies with Long Maturity Forward Rates (2008)
Working Paper: Forecasting Exchange Rates of Major Currencies with Long Maturity Forward Rates (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:cvh:coecwp:2020/01

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