Conventional and unconventional approaches to exchange rate modelling and assessment

Abstract

We examine the relative predictive power of the sticky price monetary model, uncovered interest parity, and a transformation of net exports and net foreign assets. In addition to bringing Gourinchas and Rey's new approach and more recent data to bear, we implement the Clark-West procedure for testing the significance of out-of-sample forecasts. The interest rate parity relation holds better at long horizons and the net exports variable does well in predicting exchange rates at short horizons in sample. In out-of-sample forecasts, we find evidence that our proxy for Gourinchas and Rey's measure of external imbalances outperforms a random walk at short horizons as do some of the other models, although no single model uniformly beats the random walk forecast. Copyright © 2007 John Wiley & Sons, Ltd.

Commodity prices, interest rates and the dollar

“…This is consistent with the exchange rate disconnect puzzle and the empirical evidence suggesting that apart from own shocks, the real exchange rate largely moves in response to interest rate changes; see e.g. Alquist and Chinn (2008) and the references therein. We note that shocks to food prices account for a larger share of real exchange rate fluctuations than oil price shocks.…”

The Predictive Information Content of External Imbalances for Exchange Rate Returns: How Much Is It Worth?

“…Put another way, nxa would have helped a real-world investor bene…t from fundamentals-based currency speculation, as one would expect from a state variable that summarizes the expectations of rational economic agents about future exchange rate returns. We view this result as very encouraging, given the evidence provided 2 Alquist and Chinn (2008) also emphasize the need to move to bilateral exchange rates and test the ability of nxa to forecast three US bilateral exchange rates. They …nd good in-sample results but poor out-of-sample evidence.…”

Currency Premia and Global Imbalances

“…When the FX literature has investigated the empirical link between exchange rates and external imbalances, the analysis was carried out in a time series setting (e.g. Alquist and Chinn, 2008;Della Corte, Sarno and Sestieri, 2012;Habib and Stracca, 2012). It thus seems quite natural to employ a cross-sectional perspective on the role of global imbalances to help understand currency risk premia in general, and carry trades in particular.…”