Can Exchange Rates Forecast Commodity Prices?

49 Pages Posted: 28 Jul 2008 Last revised: 6 May 2010

See all articles by Yu-Chin Chen

Yu-Chin Chen

University of Washington - Department of Economics

Kenneth Rogoff

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Barbara Rossi

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Barcelona Graduate School of Economics

Date Written: June 29, 2008

Abstract

This paper demonstrates that "commodity currency" exchange rates have remarkably robust power in predicting future global commodity prices, both in sample and out-of-sample. A critical element of our in-sample approach is to allow for structural breaks, endemic to empirical exchange rate models, by implementing the approach of Rossi (2005b). Aside from its practical implications, our forecasting results provide perhaps the most convincing evidence to date that the exchange rate depends on the present value of identifiable exogenous fundamentals. We also find that the reverse relationship holds; that is, that commodity prices Granger-cause exchange rates. However, consistent with the vast post-Meese-Rogoff (1983a,b) literature on forecasting exchange rates, we find that the reverse forecasting regression does not survive out-of-sample testing. We argue, however, that it is quite plausible that exchange rates will be better predictors of exogenous commodity prices than vice-versa, because the exchange rate is fundamentally forward looking. Therefore, following Campbell and Shiller (1987) and Engel and West (2005), the exchange rate is likely to embody important information about future commodity price movements well beyond what econometricians can capture with simple time series models. In contrast, prices for most commodities are extremely sensitive to small shocks to current demand and supply, and are therefore likely to be less forward looking.

Keywords: Exchange rates, forecasting, commodity prices, random walk

JEL Classification: C52, C53, F31, F47

Suggested Citation

Chen, Yu-Chin and Rogoff, Kenneth S. and Rossi, Barbara, Can Exchange Rates Forecast Commodity Prices? (June 29, 2008). Economic Research Initiatives at Duke (ERID) Working Paper No. 1. Available at SSRN: https://ssrn.com/abstract=1183164 or http://dx.doi.org/10.2139/ssrn.1183164

Yu-Chin Chen

University of Washington - Department of Economics ( email )

Box 353330
Seattle, WA 98195-3330
United States
206-543-6197 (Phone)

HOME PAGE: http://faculty.washington.edu/yuchin

Kenneth S. Rogoff

Harvard University - Department of Economics ( email )

Littauer Center
Room 232
Cambridge, MA 02138
United States
617-495-4022 (Phone)
617-495-7730 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Barbara Rossi (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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