IDENTIFYING EXCHANGE RATE COMMON FACTORS

Ryan Greenaway‐McGrevy, Nelson Mark, Donggyu Sul () and Jyh‐Lin Wu
Authors registered in the RePEc Author Service: Ryan Greenaway-McGrevy

International Economic Review, 2018, vol. 59, issue 4, 2193-2218

Abstract: Using recently developed model selection procedures, we determine that exchange rate returns are driven by a two‐factor model. We identify them as a dollar factor and a euro factor. Exchange rates are thus driven by global, U.S., and euro‐zone stochastic discount factors. The identified factors can also be given a risk‐based interpretation. Identification motivates multilateral models for bilateral exchange rates. Out‐of‐sample forecast accuracy of empirically identified multilateral models dominates the random walk and a bilateral purchasing power parity fundamentals prediction model. Twenty‐four‐month‐ahead forecast accuracy of the multilateral model dominates those of a principal components forecasting model.

Date: 2018
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https://doi.org/10.1111/iere.12334

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Working Paper: Identifying Exchange Rate Common Factors (2017)
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