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

Pasquale Della Corte; Lucio Sarno; Giulia Sestieri

doi:10.1162/rest_a_00157

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

Pasquale Della Corte; Lucio Sarno^1,2,3,4; Giulia Sestieri⁵

¹ Center for Economic and Policy Research · ² University of Cambridge · ³ Cambridge School · ⁴ Centre for Economic Policy Research · ⁵ Banque de France

The Review of Economics and Statistics 2012

This paper examines the exchange rate predictability stemming from the equilibrium model of international financial adjustment developed by Gourinchas and Rey (2007). Using predictive variables that measure cyclical external imbalances for country pairs, we assess the ability of this model to forecast out-of-sample four major U.S. dollar exchange rates using various economic criteria of model evaluation. The analysis shows that the model provides economic value to a risk-averse investor, delivering substantial utility gains when switching from a portfolio strategy based on the random walk benchmark to one that conditions on cyclical external imbalances.

DOI: 10.1162/rest_a_00157
Volume: 94 (1)
Pages: 100-115
Language: en
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