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An economic evaluation of empirical exchange rate models
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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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Official URL: http://www.cepr.org/pubs/new-dps/dplist.asp?dpno=6...
Abstract
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) | ||||
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| 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 | ||||
| Dates: |
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| Number: | No.659 | ||||
| Number of Pages: | 43 | ||||
| Institution: | University of Warwick | ||||
| Status: | Not Peer Reviewed | ||||
| Access rights to Published version: | Open Access |
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