Abhyankar, Abhay, 1951-, Sarno, Lucio and Valente, Giorgio (2004) Exchange rates and fundamentals: evidence on the economic value of predictability. Discussion Paper. London: Centre for Economic Policy Research (Great Britain). (Discussion paper (Centre for Economic Policy Research (Great Britain)).

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Abstract

A major puzzle in international finance is the inability of models based on monetary fundamentals to produce better out-of-sample forecasts of the nominal exchange rate than a naive random walk. While prior research has generally evaluated exchange rate forecasts using conventional statistical measures of forecast accuracy, in this Paper we investigate whether there is any economic value to the predictive power of monetary fundamentals for the exchange rate. We estimate, using a framework that allows for parameter uncertainty, the economic and utility gains to an investor who manages a portfolio based on exchange rate forecasts from a monetary fundamentals model. In contrast to much previous research, we find that the economic value of the exchange rate forecasts implied by monetary fundamentals can be substantially greater than the economic value of forecasts obtained using a random walk across a range of horizons.

Item Type:	Working or Discussion Paper (Discussion Paper)
Subjects:	H Social Sciences > HB Economic Theory
Divisions:	Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH):	Random walks (Mathematics), Economic forecasting, Foreign exchange rates, Investments
Series Name:	Discussion paper (Centre for Economic Policy Research (Great Britain))
Publisher:	Centre for Economic Policy Research (Great Britain)
Place of Publication:	London
Date:	April 2004
Number:	No.436
Number of Pages:	48
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/1718

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