Model Uncertainty and Exchange Rate Forecasting

Roy Kouwenberg, Agnieszka Markiewicz (), Ralph Verhoeks and Remco Zwinkels ()

Journal of Financial and Quantitative Analysis, 2017, vol. 52, issue 1, 341-363

Abstract: Exchange rate models with uncertain and incomplete information predict that investors focus on a small set of fundamentals that changes frequently over time. We design a model selection rule that captures the current set of fundamentals that best predicts the exchange rate. Out-of-sample tests show that the forecasts made by this rule significantly beat a random walk for 5 out of 10 currencies. Furthermore, the currency forecasts generate meaningful investment profits. We demonstrate that the strong performance of the model selection rule is driven by time-varying weights attached to a small set of fundamentals, in line with theory.

Date: 2017
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Citations: View citations in EconPapers (20)

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