Heterogeneous Agents, the Financial Crisis and Exchange Rate Predictability

Daniel Buncic and Gion Donat Piras ()

No 1436, Economics Working Paper Series from University of St. Gallen, School of Economics and Political Science

Abstract: We construct an empirical heterogeneous agent model which optimally combines forecasts from fundamentalist and chartist agents and evaluates its out-of-sample forecast performance using daily data covering an overall period from January 1999 to June 2014 for six of the most widely traded currencies. We use daily financial data such as level, slope and curvature yield curve factors, equity prices, as well as risk aversion and global trade activity measures in the fundamentalist agent’s predictor set to obtain a proxy for the market’s view on the state of the macroeconomy. Chartist agents rely upon standard momentum, moving average and relative strength index technical indicators in their predictor set. Individual agent specific forecasts are constructed using a flexible dynamic model averaging framework and are then aggregated into a model combined forecast using a forecast combination regression. We show that our empirical heterogeneous agent model produces statistically significant and sizable forecast improvements over a random walk benchmark, reaching out-of-sample R2 values of 1.41, 1.07, 0.99 and 0.74 percent at the daily one-step ahead horizon for 4 out of the 6 currencies that we consider. Forecast gains remain significant for horizons up to threedays ahead. The forecast improvements are largely realised before and around the time of the Lehman Brothers collapse. We show further that our model combined forecasts produce economic value to a mean variance investor, yielding annualized Sharpe ratios of around 0.89 and annualized performance fees in excess of 460 basis points.

Keywords: Empirical heterogeneous agent model; forecasting; time varying parameter model; statespace modelling; model combination; exchange rate predictability; financial crisis (search for similar items in EconPapers)
JEL-codes: C22 C52 C53 E17 F31 G17 (search for similar items in EconPapers)
Pages: 68 pages
Date: 2014-12, Revised 2015-10
New Economics Papers: this item is included in nep-for and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Journal Article: Heterogeneous agents, the financial crisis and exchange rate predictability (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:usg:econwp:2014:36

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