Common factors and the exchange rate: results from the Brazilian case

Wilson Rafael de Oliveira Felício and José Luiz Rossi Júnior

No 183, Business and Economics Working Papers from Unidade de Negocios e Economia, Insper

Abstract: This paper studies the usefulness of factor models in explaining the dynamics of the exchange rate Real / Dollar from January 1999 to August 2011. The paper verifies that the inclusion of factors embedded on the common movements of exchange rates of a set of countries significantly improves the in-sample and out-of-sample predictive power of the models comprising only macroeconomic fundamentals commonly used in the literature to forecast the exchange rate. The paper also links the information contained in the factors toglobal shocks like the demand for dollars – a “dollar effect”, volatility and liquidity of global financial markets.

Pages: 30 pages
Date: 2013
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