Journal of Financial and Quantitative Analysis Vol. 52 No. 1 2017

Model Uncertainty and Exchange Rate Forecasting

Roy Kouwenberg^1,2,3,4; Agnieszka Markiewicz^1,2,3,4; Ralph Verhoeks^1,2,3,4; Remco C. J. Zwinkels^1,2,3,4

¹ Mahidol University · ² Vrije Universiteit Amsterdam · ³ Erasmus University Rotterdam · ⁴ De Nederlandsche Bank

Abstract

Exchange rate models with uncertain and incomplete information predict that investors focus on a small set of fundamentals that changes frequently over time. We design a model selection rule that captures the current set of fundamentals that best predicts the exchange rate. Out-of-sample tests show that the forecasts made by this rule significantly beat a random walk for 5 out of 10 currencies. Furthermore, the currency forecasts generate meaningful investment profits. We demonstrate that the strong performance of the model selection rule is driven by time-varying weights attached to a small set of fundamentals, in line with theory.

DOI

10.1017/s0022109017000011

Volume

52

Issue

1

Pages

341-363

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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