Journal
ECONOMETRIC REVIEWS
Volume 34, Issue 1-2, Pages 32-55Publisher
TAYLOR & FRANCIS INC
DOI: 10.1080/07474938.2014.944467
Keywords
Forecasting; Exchange rates; Factor models
Categories
Funding
- National Science Foundation
- Direct For Social, Behav & Economic Scie
- Divn Of Social and Economic Sciences [1127527] Funding Source: National Science Foundation
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We construct factors from a cross-section of exchange rates and use the idiosyncratic deviations from the factors to forecast. In a stylized data generating process, we show that such forecasts can be effective even if there is essentially no serial correlation in the univariate exchange rate processes. We apply the technique to a panel of bilateral U.S. dollar rates against 17 Organisation for Economic Co-operation and Development countries. We forecast using factors, and using factors combined with any of fundamentals suggested by Taylor rule, monetary and purchasing power parity models. For long horizon (8 and 12 quarter) forecasts, we tend to improve on the forecast of a no change benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.
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