Short-Run Forecasting of the Euro-Dollar Exchange Rate with Economic Fundamentals

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 fit and, more importantly, encouraging out-of-sample forecasting results at horizons ranging from one-week to one month. Specifically, we obtain statistically significant improvements upon the hard-to-beat random-walk model using traditional statistical measures of forecasting error at all horizons. Moreover, our model obtains a great improvement 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 as an equal chance to go up or down, with statistically significant improvements.

Short-Term Forecasting for Empirical Economists. A Survey of the Recently Proposed Algorithms

“…Kim (1994) proposes an approximation that consist of a weighted average of the updating procedures by the probabilities of the Markov state, in which the mixture of Gaussian densities is collapsed after each observation. 18 The main advantage of these nonlinear models is that they convert the information MF-VAR and factor models are model-driven as they are cast in state space forms and estimated by using the Kalman …lter. However, MIDAS and bridge equations are observation-driven as they are formulated exclusively in terms of observable data and do not involve latent processes, which avoids the need to formulate measurement equations and …ltering.…”

Forecasting Errors, Directional Accuracy and Profitability of Currency Trading: The Case of EUR/USD Exchange Rate

“…The aim of this paper is to offer the most comprehensive analysis to date of the out-of-sample forecasting performance of macro-econometric models of the exchange rate between the euro (EUR) and the US dollar (USD) in terms of predictive error, directional accuracy and profitability of trading strategies. The EUR/USD exchange rate plays a central role in global financial markets, and understanding its dynamics has been the goal of countless studies (see, for example, Dal Bianco et al, 2012;King et al, 2012). Since both currencies act as an anchor or reference currency and are used as an international store of value (Dal Bianco et al, 2012), the EUR and USD are the most traded currencies worldwide by value.…”

“…The EUR/USD exchange rate plays a central role in global financial markets, and understanding its dynamics has been the goal of countless studies (see, for example, Dal Bianco et al, 2012;King et al, 2012). Since both currencies act as an anchor or reference currency and are used as an international store of value (Dal Bianco et al, 2012), the EUR and USD are the most traded currencies worldwide by value.…”

“…Models for the EUR/USD exchange rate based on macroeconomic fundamentals are used in Jamaleh (2002), Karfakis (2006), Molodtsova et al (2011) andDal Bianco et al (2012), whereas Sosvilla-Rivero and Garcí (2005) and Hsing and Sergi (2009) apply frameworks based on the purchasing power parity (PPP) equilibrium, and Heimonen (2009) considers an equity flow model. 1 In most of these works predictive accuracy is assessed using standard loss Forecasting Errors, Directional Accuracy and Profitability 653 accuracy measures, encompassing testing procedures (Jamaleh, 2002;Dal Bianco et al, 2012), and metrics to detect the percentage of correct predictions of the direction of changes (Jamaleh, 2002;Sosvilla-Rivero and Garcí, 2005;Karfakis, 2006;Heimonen, 2009;Dal Bianco et al, 2012). While the findings of the literature show a tendency for the benchmark random walk model to be outperformed, the predictive superiority of alternative modelling frameworks is not properly assessed in terms of multiple hypotheses, which implies that the results may be generated by chance.…”

Nature of Exchange Rates Cyclicality in Central and Eastern European Countries

“…As an illustration, we can use monetary class of models. Although each model that belongs to this family introduces some specific attributes we are able to derive a conventional set of fundamentals that is shared by the entire group of monetary models of exchange rate determination [2]. This set of fundamentals consists of money supply, gross domestic product or income, long-term interest rate, inflation rate and trade balance.…”