short-run forecasting of the euro-dollar exchange rate ... · short-run forecasting of the...

SHORT-RUN FORECASTING OF THE EURO-DOLLAR EXCHANGE RATE WITH ECONOMIC FUNDAMENTALS

Marcos dal Bianco, Maximo Camacho and Gabriel Perez-Quiros

Documentos de Trabajo N. 1203

2012

SHORT-RUN FORECASTING OF THE EURO-DOLLAR EXCHANGE RATE WITH

ECONOMIC FUNDAMENTALS

SHORT-RUN FORECASTING OF THE EURO-DOLLAR EXCHANGE RATE WITH ECONOMIC FUNDAMENTALS (*)

Marcos dal Bianco

BBVA RESEARCH

Maximo Camacho

UNIVERSIDAD DE MURCIA

Gabriel Perez-Quiros

BANCO DE ESPAA

(*) Camacho acknowledges financial support from MICINN (ECO2010-19830). The authors are grateful to the editor, the anonymous referees, participants to the Econometrics Workshop at the University of Alicante, XXXII Symposium on Economic Analysis, and the XLV Meeting of the Argentinean Association of Political Economy for their very useful comments. Any remaining errors are our own responsibility. The views in this paper are those of the authors and do not represent the views of the Bank of Spain.

Documentos de Trabajo. N. 1203

2012

The Working Paper Series seeks to disseminate original research in economics and fi nance. All papers have been anonymously refereed. By publishing these papers, the Banco de Espaa aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment.

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BANCO DE ESPAA, Madrid, 2012

ISSN: 1579-8666 (on line)

Abstract

We propose a fundamentals-based econometric model for the weekly changes in the

euro-dollar rate with the distinctive feature of mixing economic variables quoted at different

frequencies. The model obtains good in-sample fi t and, more importantly, encouraging out-

of-sample forecasting results at horizons ranging from one week to one month. Specifi cally,

we obtain statistically signifi cant improvements upon the hard-to-beat random walk model

using traditional statistical measures of forecasting error at all horizons. Moreover, our model

improves greatly when we use the direction-of-change metric, which has more economic

relevance than other loss measures. With this measure, our model performs much better

at all forecasting horizons than a naive model that predicts the exchange rate has an equal

chance to go up or down, with statistically signifi cant improvements.

Keywords: euro-dollar rate, exchange rate forecasting, State-space model, mixed

frequencies.

JEL classifi cation: F31, F37, C01, C22.

Resumen

Se propone un modelo economtrico basado en fundamentales para el cambio semanal del

tipo de cambio del euro frente al dlar con la caracterstica diferencial de mezclar variables

con diferentes frecuencias. El modelo obtiene buenas predicciones en la muestra, y, lo

que es ms importante, mejoras en prediccin fuera de la muestra a horizontes entre una

semana y un mes. Especfi camente, obtenemos mejoras estadsticamente signifi cativas

frente al difcil de batir paseo aleatorio, usando las medidas tradicionales basadas en error

de prediccin cuadrtico medio a todos los horizontes. Las ganancias son mayores cuando

utilizamos la mtrica basada en la direccin del cambio, que tiene ms sentido econmico en

un modelo como este. Con esta medida, nuestro modelo predice los movimientos alcistas

y bajistas del tipo de cambio mucho mejor que un modelo basado en igual probabilidad de

bajadas y subidas.

Palabras claves: Tipo de cambio euro-dlar, prediccin de tipos de cambio, modelo de

ecuacin de estados y frecuencias mixtas.

Cdigos JEL: F31, F37, C01, C22.

BANCO DE ESPAA 7 DOCUMENTO DE TRABAJO N. 1203


0.75

1

1.25

1.5

1.75

Jan-

99

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9

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Source: Datastream

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Source: Datastream

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Source: Datastream

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exchange rate with economic fundamentals.

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SHORT-RUN FORECASTING OF THE EURO-DOLLAR EXCHANGE RATE WITH ECONOMIC FUNDAMENTALSAbstractResumen1 Introduction2 Brief literature review3 Fundamental determinants of exchange rates4 The econometric model5 Empirical results6 ConclusionsAppendix 1: Description of the dataReferencesTables and FiguresBANCO DE ESPAA PUBLICATIONS

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