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

Abstract

This paper examines the exchange rate predictability stemming from the equilibrium model of international …nancial adjustment developed by Gourinchas and Rey (2007). Using theoreticallymotivated predictive variables that measure cyclical external imbalances for country pairs, we assess the ability of this model to forecast out-of-sample four major US dollar exchange rates using criteria of economic pro…tability. The analysis shows that the model delivers tangible economic value to a risk averse investor, who will pay high performance fees to switch from a portfolio strategy based on the random walk benchmark to one that conditions on the structural model. The results are robust to the presence of reasonable transaction costs across various forecasting performance criteria, and they are further enhanced when sensible economic restrictions are imposed on the predictive model. JEL classi…cation: F31; F37; G15.

Exchange rate expectations since the financial crisis: Performance evaluation and the role of monetary policy and safe haven

“…In addition, Sharpe ratios for both momentum and expectation based trading are small, reflecting the turbulence on currency markets over the sample period. One has to keep in mind, however, that Sharpe ratios underestimate the performance of dynamic strategies since they overestimate the conditional risk an investor faces at each point in time due to the full sample standard deviation they consider (Marquering and Verbeek, 2004;Han, 2006;Della Corte et al, 2012). Nevertheless, the results confirm that expectations are useful from an economic perspective despite their weak statistical performances illustrated before.…”

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.…”

Capital flows and GDP in emerging economies and the role of global spillovers

“…We therefore analyze effects of capital flows on both exchange rates and GDP. Some studies indeed have provided evidence for forecasting power of net foreign asset positions and capital flows on bilateral exchange rates (Della Corte et al, 2012). Another strand of the literature considers the opposite causality, for example by analyzing the effect of exchange rate uncertainty on different components of net portfolio flows (Caporale et al, 2015).…”