Factor Model Forecasts of Exchange Rates
Nelson Mark
No 12, Working Papers from University of Notre Dame, Department of Economics
Abstract:
We construct factors from a cross section of exchange rates and use the idiosyncratic deviations from the factors to forecast. In a stylized data generating process, we show that such forecasts can be effective even if there is essentially no serial correlation in the univariate exchange rate processes. We apply the technique to a panel of bilateral U.S. dollar rates against 17 OECD countries. We forecast using factors, and using factors combined with any of fundamentals suggested by Taylor rule, monetary and purchasing power parity (PPP) models. For long horizon (8 and 12 quarter) forecasts, we tend to improve on the forecast of a ³no change² benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.
Keywords: Exchange Rates; Factor Models; Forecasting (search for similar items in EconPapers)
JEL-codes: F31 F37 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2008-11, Revised 2012-01
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Citations: View citations in EconPapers (22)
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Related works:
Journal Article: Factor Model Forecasts of Exchange Rates (2015) 
Working Paper: Factor Model Forecasts of Exchange Rates (2012) 
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