An economic evaluation of empirical exchange rate models
Della Corte, Pasquale, Sarno, Lucio and Tsiakas, Ilias (2007) An economic evaluation of empirical exchange rate models. Discussion Paper. London: Centre for Economic Policy Research (Great Britain). Discussion paper (Centre for Economic Policy Research (Great Britain)) (No.659).
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This paper provides a comprehensive evaluation of the short-horizon predictive ability of economic fundamentals and forward premia on monthly exchange rate returns in a framework that allows for volatility timing. We implement Bayesian methods for estimation and ranking of a set of empirical exchange rate models, and construct combined forecasts based on Bayesian Model Averaging. More importantly, we assess the economic value of the in-sample and out-of-sample forecasting power of the empirical models, and find two key results: (i) a risk averse investor will pay a high performance fee to switch from a dynamic portfolio strategy based on the random walk model to one which conditions on the forward premium with stochastic volatility innovations; and (ii) strategies based on combined forecasts yield large economic gains over the random walk benchmark. These two results are robust to reasonably high transaction costs.
|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):||Foreign exchange rates -- Mathematical models, Bayesian statistical decision theory, Economic forecasting, Risk perception|
|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:||December 2007|
|Number of Pages:||43|
|Status:||Not Peer Reviewed|
|Access rights to Published version:||Open Access|
Abhyankar, A., L. Sarno, and G. Valente (2005). �Exchange Rates and Fundamentals: Evidence on
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