Do macroeconomic variables drive exchange rates independently?

Rita Biswas, Xiao Li and Louis R. Piccotti

Finance Research Letters, 2023, vol. 52, issue C

Abstract: The classical practice in exchange rate model estimation is to use bilateral differentials of macroeconomic variables. Empirically, capital may not place equal importance on the economic variables among all countries. Therefore, allowing each country's variable to enter the model independently may reduce estimation error. Based on simulations, we find that higher correlations between the two countries’ variables tend to inflate prediction errors when the estimation uses bilateral differentials. Applying the Sticky Price Monetary Model (SPMM) to a wide range of countries we find supportive evidence for separating the variables, a finding especially relevant for smaller economies.

Keywords: Exchange rate determination; Macro fundamental models; Machine learning regression; Elastic net (search for similar items in EconPapers)
JEL-codes: G15 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:52:y:2023:i:c:s1544612322007000

DOI: 10.1016/j.frl.2022.103524

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