Forecasting the daily exchange rate of the UK pound sterling against the US dollar

Zsolt Darvas and Zoltán Schepp

Finance Research Letters, 2025, vol. 71, issue C

Abstract: This paper is the first to use an economic theory-based model—the monetary model of exchange rates within a rational expectations present value framework—to forecast the daily exchange rate of a major currency. Our out-of-sample forecast evaluation period, spanning from 1990 to 2024, is longer than that of any other exchange rate forecasting study. We find that our model's forecasts outperform the random walk across all forecasting horizons, ranging from one day to five years. Moreover, a trading strategy based on our model's forecasts yields economically and statistically significant excess returns, surpassing those of the carry trade strategy.

Keywords: Currency trading; Exchange rates; Error correction; Forecasting; Monetary model; Out-of-sample; Random walk (search for similar items in EconPapers)
JEL-codes: F31 F37 G15 G17 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:71:y:2025:i:c:s1544612324014806

DOI: 10.1016/j.frl.2024.106451

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