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Exchange rates and fundamentals: footloose or evolving relationship?

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Sarno, Lucio and Valente, Giorgio (2008) Exchange rates and fundamentals: footloose or evolving relationship? Discussion Paper. London: Centre for Economic Policy Research (Great Britain). Discussion paper (Centre for Economic Policy Research (Great Britain)) (No.663).

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Abstract

Using novel real-time data on a broad set of economic fundamentals for five major US dollar exchange rates over the recent float, we employ a predictive procedure that allows the relationship between exchange rates and fundamentals to evolve over time in a very general fashion. Our key findings are that: (i) the well-documented weak out-of-sample predictive ability of exchange rate models may be caused by poor performance of model-selection criteria, rather than lack of information content in the fundamentals; (ii) the difficulty of selecting the best predictive model is largely due to frequent shifts in the set of fundamentals driving exchange rates, which can be interpreted as reflecting swings in market expectations over time. However, the strength of the link between exchange rates and fundamentals is different across currencies.

Item Type:

Working or Discussion Paper (Discussion Paper)

Subjects:

H Social Sciences > HG Finance

Divisions:

Faculty of Social Sciences > Warwick Business School

Library of Congress Subject Headings (LCSH):

Dollar, American, Foreign exchange rates -- United States, Economic forecasting

Series Name:

Discussion paper (Centre for Economic Policy Research (Great Britain))

Publisher:

Centre for Economic Policy Research (Great Britain)

Place of Publication:

London

Official Date:

January 2008

Dates:

Date	Event
January 2008	Published

Number:

No.663

Number of Pages:

Status:

Not Peer Reviewed

Access rights to Published version:

Open Access

Funder:

Economic and Social Research Council (Great Britain) (ESRC), Chinese University of Hong Kong (CUHK)

Grant number:

RES-000-22-0404 (ESRC), 2070350 (CUHK)

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