A new approach to exchange rate forecast: The role of global financial cycle andtime-varyingparameters

Ibrahim D. Raheem, Xuan Vinh Vo

Research output: Contribution to journalArticlepeer-review

Abstract

The exchange rate disconnect puzzle argues that macroeconomic fundamentals are not able to accurately predict exchange rate. Recent studies have shown that the puzzle could be upturned if: (a) the dataset is structured in a panel form; (b) the model is based on the portfolio balance theory (PBT); (c) factor models are employed and (d) time-varying parameter (TVP) regression is used. This study combines these strands of the literature. Essentially, the study conjectures that Global Financial Cycle (GFCy), drawing inspiration from PBT, has some predictive information content on exchange rate. Using dataset from 25 countries, we produced some mixed results. On the whole, the GFCy is able to produce lower forecast error, as compared to the that of benchmark model. However, its effectiveness is dependent upon the regression type (TVP vs. Panel Fixed Effect); forecast horizons (short vs. long); the sample period (early vs. late) and measures of GFCy. The results are robust to a number of checks.

Original languageEnglish
Number of pages13
JournalInternational Journal of Finance & Economics
Early online date22 Oct 2020
DOIs
Publication statusE-pub ahead of print - 22 Oct 2020

Keywords

  • exchange rate
  • forecasting
  • global financial cycle and time-varying parameters
  • MODEL

Cite this