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The term structure of exchange rate predictability: Commonality, scapegoat, and disagreement

Shuo Cao, Huichou Huang, Ruirui Liu and Ronald MacDonald

Journal of International Money and Finance, 2019, vol. 95, issue C, 379-401

Abstract: In this paper, we study the exchange rate predictability across a range of investment horizons by proposing a generalized (term structure) model to capture the dynamics between the risk premium component of exchange rates and a broad set of variables meanwhile handle both parameter and model uncertainty. We also demonstrate the projections of common predictable information over the term structure, and existence of time-varying term-structural effect and model disagreement effect of exchange rate predictors in FX trading, which in turn validates the practical use of our model. We then utilize the time-variation in the probability weighting to identify the scapegoat drivers of customer order flows. We further comprehensively evaluate both statistical and economic significance of the model allowing for a full spectrum of currency investment management, and find that the model generates substantial performance fees of 6.5% per annum.

Keywords: Exchange rate forecasting; Disconnect puzzle; Carry trade risk premia; Term structure factors; Scapegoat variables; Model disagreement; Customer order flows (search for similar items in EconPapers)
JEL-codes: C52 E43 F31 F37 G11 (search for similar items in EconPapers)
Date: 2019
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Working Paper: The Term Structure of Exchange Rate Predictability: Commonality, Scapegoat, and Disagreement (2017) Downloads
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DOI: 10.1016/j.jimonfin.2018.03.013

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