On the Sources of Uncertainty in Exchange Rate Predictability

48 Pages Posted: 29 Sep 2014 Last revised: 16 Sep 2016

See all articles by Joseph Byrne

Joseph Byrne

Heriot-Watt University - Department of Accountancy, Economics and Finance

Dimitris Korobilis

University of Glasgow - Adam Smith Business School

Pinho Ribeiro

University of Glasgow - Adam Smith Business School

Date Written: September 15, 2016

Abstract

In a unified framework, we examine four sources of uncertainty in exchange rate forecasting models: (i) random variations in the data, (ii) estimation uncertainty, (iii) uncertainty about the degree of time-variation in coefficients, and (iv) uncertainty regarding the choice of the predictor. We find that models which embed a high-degree of coefficient variability yield forecast improvements at horizons beyond 1-month. At the 1-month horizon, and apart from the standard variance implied by unpredictable fluctuations in the data, the second and third sources of uncertainty listed above are key obstructions to predictive ability. The uncertainty regarding the choice of the predictors is negligible.

Keywords: Exchange rate forecasting, Instabilities, Time-varying parameter models, Bayesian model selection, Forecast combination

JEL Classification: C53, C55, E44, F37, G11

Suggested Citation

Byrne, Joseph and Korobilis, Dimitris and Ribeiro, Pinho, On the Sources of Uncertainty in Exchange Rate Predictability (September 15, 2016). Available at SSRN: https://ssrn.com/abstract=2502586 or http://dx.doi.org/10.2139/ssrn.2502586

Joseph Byrne

Heriot-Watt University - Department of Accountancy, Economics and Finance ( email )

Scotland
United Kingdom

Dimitris Korobilis

University of Glasgow - Adam Smith Business School ( email )

40 University Avenue
Gilbert Scott Building
Glasgow, Scotland G12 8QQ
United Kingdom

HOME PAGE: http://https://sites.google.com/site/dimitriskorobilis/

Pinho Ribeiro (Contact Author)

University of Glasgow - Adam Smith Business School ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

HOME PAGE: http://www.sites.google.com/site/pinhojribeiro/research

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