Della Corte, Pasquale, Sarno, Lucio and Tsiakas, Ilias. (2009) An economic evaluation of empirical exchange rate models. Review of Financial Studies, Vol.22 (No.9). pp. 3491-3530. ISSN 0893-9454

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Abstract

This paper provides a comprehensive evaluation of the short-horizon predictive ability of economic fundamentals and forward premiums 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: (1) 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 that conditions on the forward premium with stochastic volatility innovations and (2) 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:	Journal Article
Subjects:	H Social Sciences > HG Finance H Social Sciences > HC Economic History and Conditions
Divisions:	Faculty of Social Sciences > Warwick Business School > Finance Group Faculty of Social Sciences > Warwick Business School
Journal or Publication Title:	Review of Financial Studies
Publisher:	Oxford University Press
ISSN:	0893-9454
Date:	September 2009
Volume:	Vol.22
Number:	No.9
Number of Pages:	40
Page Range:	pp. 3491-3530
Identification Number:	10.1093/rfs/hhn058
Status:	Peer Reviewed
Publication Status:	Published
Access rights to Published version:	Restricted or Subscription Access
URI:	http://wrap.warwick.ac.uk/id/eprint/17309

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