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Forecasting Exchange Rates under Model and Parameter Uncertainty

Joscha Beckmann () and Rainer Schüssler

No 3214, CQE Working Papers from Center for Quantitative Economics (CQE), University of Muenster

Abstract: We introduce a forecasting method that closely matches the econometric properties required by the theory on exchange rate prediction. Our approach formally models (i) when (and if) explanatory variables enter or leave a regression model, (ii) the degree of parameter instability, (iii) the (potentially) rapidly changing relevance of regressors, and (iv) the appropriate shrinkage intensity over time. We consider (short-term) forecasting of six major US dollar exchange rates using a standard set of macro fundamentals. Our results indicate the importance of shrinkage and flexible model selection/averaging criteria to avoid poor forecasting results.

Keywords: Exchange rates forecasting; time-varying parameter models; shrinkage; model selection/averaging (search for similar items in EconPapers)
JEL-codes: F31 F37 G17 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2014-08
New Economics Papers: this item is included in nep-ets, nep-for and nep-ore
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