Identifying Exchange Rate Common Factors / Ryan Greenaway-McGrevy, Donggyu Sul, Nelson Mark, Jyh-Lin Wu.

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Greenaway-McGrevy, Ryan

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w23726.Publication details: Cambridge, Mass. National Bureau of Economic Research 2017.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: Using recently developed model selection procedures, we determine that exchange rate returns are driven by a two-factor model. We identify them as a dollar factor and a euro factor. Exchange rates are thus driven by global, US, and Euro-zone stochastic discount factors. The identified factors can also be given a risk-based interpretation. Identification motivates multilateral models for bilateral exchange rates. Out-of-sample forecast accuracy of empirically identified multilateral models dominate the random walk and a bilateral purchasing power parity fundamentals prediction model. 24-month ahead forecast accuracy of the multilateral model dominates those of a principal components forecasting model.

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Working Paper	Biblioteca Digital	Colección NBER	nber w23726 (Browse shelf(Opens below))	Not For Loan

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August 2017.

Using recently developed model selection procedures, we determine that exchange rate returns are driven by a two-factor model. We identify them as a dollar factor and a euro factor. Exchange rates are thus driven by global, US, and Euro-zone stochastic discount factors. The identified factors can also be given a risk-based interpretation. Identification motivates multilateral models for bilateral exchange rates. Out-of-sample forecast accuracy of empirically identified multilateral models dominate the random walk and a bilateral purchasing power parity fundamentals prediction model. 24-month ahead forecast accuracy of the multilateral model dominates those of a principal components forecasting model.