Factor Model Forecasts of Exchange Rates

Charles Engel, Nelson Mark and Kenneth West ()

No 18382, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We construct factors from a cross section of exchange rates and use the idiosyncratic deviations from the factors to forecast. In a stylized data generating process, we show that such forecasts can be effective even if there is essentially no serial correlation in the univariate exchange rate processes. We apply the technique to a panel of bilateral U.S. dollar rates against 17 OECD countries. We forecast using factors, and using factors combined with any of fundamentals suggested by Taylor rule, monetary and purchasing power parity (PPP) models. For long horizon (8 and 12 quarter) forecasts, we tend to improve on the forecast of a "no change" benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.

JEL-codes: C53 C58 F37 G17 (search for similar items in EconPapers)
Date: 2012-09
New Economics Papers: this item is included in nep-cba, nep-for, nep-mon and nep-opm
Note: AP IFM ME
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Citations: View citations in EconPapers (20)

Published as Charles Engel & Nelson C. Mark & Kenneth D. West, 2015. "Factor Model Forecasts of Exchange Rates," Econometric Reviews, Taylor & Francis Journals, vol. 34(1-2), pages 32-55, February.

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Working Paper: Factor Model Forecasts of Exchange Rates (2012)
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