Extracting Forward Rate Term Structure Information in Foreign Exchange

17 Pages Posted: 3 Apr 2015 Last revised: 21 Dec 2016

See all articles by Fearghal Kearney

Fearghal Kearney

Queen's University Belfast - Queen's Management School

Mark Cummins

Dublin City University Business School

Finbarr Murphy

University of Limerick - Kemmy Business School

Date Written: April 1, 2015

Abstract

The difficulty of beating the random walk in forecasting spot foreign exchange rates is well documented, with the restricted VECM of Clarida and Taylor (1997) providing the primary challenge. We seek to extract the informational content of the forward rate term structure through the implementation of a functional principal component-based scalar response model. Our out-of-sample framework leads to near systematic outperformance in terms of a direct comparison of performance measures, versus both the VECM and random walk. The results indicate that the forward rate term structure contains statistically significant information about the evolution of the spot exchange rate.

Suggested Citation

Kearney, Fearghal and Cummins, Mark and Murphy, Finbarr, Extracting Forward Rate Term Structure Information in Foreign Exchange (April 1, 2015). Available at SSRN: https://ssrn.com/abstract=2588560 or http://dx.doi.org/10.2139/ssrn.2588560

Fearghal Kearney (Contact Author)

Queen's University Belfast - Queen's Management School ( email )

Riddel Hall
185 Stranmillis Road
Belfast, BT9 5EE
United Kingdom

Mark Cummins

Dublin City University Business School ( email )

Dublin 9
Ireland

Finbarr Murphy

University of Limerick - Kemmy Business School ( email )

Limerick
Ireland

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