Short-Run Forecasting of the Euro-Dollar Exchange Rate with Economic Fundamentals

41 Pages Posted: 7 Feb 2012

See all articles by Marcos Dal Bianco

Marcos Dal Bianco

Independent

Maximo Camacho

Autonomous University of Barcelona - Department of Economics; Universidad de Murcia - Departamento de Metodos Cuantitativos

Gabriel Perez-Quiros

Banco de España

Date Written: February 7, 2012

Abstract

We propose a fundamentals-based econometric model for the weekly changes in the euro-dollar rate with the distinctive feature of mixing economic variables quoted at different frequencies. The model obtains good in-sample fit and, more importantly, encouraging out-of-sample forecasting results at horizons ranging from one week to one month. Specifically, we obtain statistically significant improvements upon the hard-to-beat random walk model using traditional statistical measures of forecasting error at all horizons. Moreover, our model improves greatly when we use the direction-of-change metric, which has more economic relevance than other loss measures. With this measure, our model performs much better at all forecasting horizons than a naive model that predicts the exchange rate has an equal chance to go up or down, with statistically significant improvements.

Keywords: euro-dollar rate, exchange rate forecasting, State-space model, mixed frequencies

JEL Classification: F31, F37, C01, C22

Suggested Citation

Dal Bianco, Marcos and Camacho, Maximo and Perez-Quiros, Gabriel, Short-Run Forecasting of the Euro-Dollar Exchange Rate with Economic Fundamentals (February 7, 2012). Banco de Espana Working Paper No. 1203, Available at SSRN: https://ssrn.com/abstract=2000677 or http://dx.doi.org/10.2139/ssrn.2000677

Maximo Camacho

Autonomous University of Barcelona - Department of Economics ( email )

Avda. Diagonal 690
Barcelona, 08034
Spain

Universidad de Murcia - Departamento de Metodos Cuantitativos ( email )

Campus de Espinardo
30100 Murcia
Spain
+34 968 367 982 (Phone)

Gabriel Perez-Quiros

Banco de España ( email )

Madrid 28014
Spain

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