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Superior Predictability of American Factors of the Won/Dollar Real Exchange Rate

Sarthak Behera (), Hyeongwoo Kim () and Soohyon Kim

No auwp2021-03, Auburn Economics Working Paper Series from Department of Economics, Auburn University

Abstract: Utilizing an array of data dimensionality reduction methods, we estimate latent common factors of the Won/Dollar real exchange rate from a large panel of economic predictors of the U.S. and South Korea. We demonstrate superior out-of-sample predictability of our factor augmented forecasting models relative to conventional models when we utilize factors obtained from U.S. economic variables, while Korean factors fail to enhance predictability. Our models perform better at longer horizons when American real activity factors are employed, whereas American nominal/financial market factors help improve short-run prediction accuracy. UIP fundamental factors with the dollar as numeraire overall perform well, while PPP and RIRP factors play a limited role in forecasting the Won/Dollar exchange rate.

Keywords: Won/Dollar Real Exchange Rate; Principal Component Analysis; Partial Least Squares; LASSO; Out-of-Sample Forecast (search for similar items in EconPapers)
JEL-codes: C38 C53 C55 F31 G17 (search for similar items in EconPapers)
Date: 2021-07
New Economics Papers: this item is included in nep-for and nep-ore
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