Can currency-based risk factors help forecast exchange rates?

Ahmed, Shamim; Liu, Xiaoquan; Valente, Giorgio

Abstract

This paper examines time-series predictability of bilateral exchange rates from linear factor models that utilize unconditional and conditional expectations of three currency-based risk factors. Exploiting a comprehensive set of statistical criteria, we find that all versions of the linear factor models largely fail to outperform the benchmark of random walk with drift model in the out-of-sample forecasting of monthly exchange rate returns. This holds true for individual currencies and currency portfolios formed on forward discounts. We also show that the information embedded in the currency-based risk factors does not generate systematic economic value to investors.

Citation

Ahmed, S., Liu, X., & Valente, G. (in press). Can currency-based risk factors help forecast exchange rates?. International Journal of Forecasting, 32(1), https://doi.org/10.1016/j.ijforecast.2015.01.010

• Journal Article Type: Article
• Acceptance Date: Aug 1, 2015
• Online Publication Date: Sep 21, 2015
• Deposit Date: Sep 19, 2016
• Publicly Available Date: Sep 19, 2016
• Journal: International Journal of Forecasting
• Print ISSN: 0169-2070
• Electronic ISSN: 0169-2070
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 32
• Issue: 1
• DOI: https://doi.org/10.1016/j.ijforecast.2015.01.010
• Keywords: Exchange rates; Out-of-sample predictability; Economic value; Time series; Econometric models
• Public URL: https://nottingham-repository.worktribe.com/output/760778
• Publisher URL: http://www.sciencedirect.com/science/article/pii/S016920701500062X
• Contract Date: Sep 19, 2016