Forecasting Euro Exchange Rates: How Much Does Model Averaging Help?

Economics and Statistics Working Paper No. 2007-24

22 Pages Posted: 25 Oct 2007

See all articles by Jesús Crespo Cuaresma

Jesús Crespo Cuaresma

University of Innsbruck - Department of Economic Theory, Economic Policy and Economic History

Date Written: 2007

Abstract

We analyze the performance of Bayesian model averaged exchange rate forecasts for euro/US dollar, euro/Japanese yen, euro/Swiss franc and euro/ British pound rates using weights based on the out-of-sample predictive likelihood. The paper also presents a simple stratified sampling procedure in the spirit of Sala i Martin et alia (2004) to obtain model weights based on predictive accuracy. Our results indicate that accounting explicitly for model uncertainty when constructing predictions of euro exchange rates leads to improvements in predictive accuracy as measured by the mean square forecast error. While the forecasting error of the combined forecast tends to be systematically smaller than that of the individual model that would have been chosen based on predictive accuracy in a test sample, random walk forecasts cannot be beaten significantly in terms of squared forecast errors. Direction of change statistics, on the other hand, are significantly improved by Bayesian model averaging.

Keywords: Forecasting, model averaging, Bayesian econometrics, exchange rates

JEL Classification: C11, C53, F31

Suggested Citation

Crespo Cuaresma, Jesús, Forecasting Euro Exchange Rates: How Much Does Model Averaging Help? (2007). Economics and Statistics Working Paper No. 2007-24. Available at SSRN: https://ssrn.com/abstract=1024150 or http://dx.doi.org/10.2139/ssrn.1024150

Jesús Crespo Cuaresma (Contact Author)

University of Innsbruck - Department of Economic Theory, Economic Policy and Economic History ( email )

Universitaetsstrasse 15
Innsbruck, A - 6020
Austria

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