Point, Interval and Density Forecasts of Exchange Rates with Time-Varying Parameter Models

34 Pages Posted: 29 Jun 2016  

Angela Abbate

Deutsche Bundesbank

Massimiliano Giuseppe Marcellino

European University Institute; European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS); Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: 2016

Abstract

We explore whether modelling parameter time variation improves the point, interval and density forecasts of nine major exchange rates vis-a-vis the US dollar over the period 1976-2015. We find that modelling parameter time variation is needed for an accurate calibration of forecast confidence intervals, and is better suited at long horizons and in high-volatility periods. The biggest forecast improvements are obtained by modelling time variation in the volatilities of the innovations, rather than in the slope parameters. Moreover, we do not find evidence that parameter time variation helps to unravel exchange rate predictability by macroeconomic fundamentals. Finally, an economic evaluation of the different forecast models reveals that controlling for parameter time variation leads to higher portfolios returns, and to higher utility values for investors.

Keywords: exchange rates, forecasting, density forecasts, BVAR, time-varying parameters

JEL Classification: C11, C53, F31, F37

Suggested Citation

Abbate, Angela and Marcellino, Massimiliano Giuseppe, Point, Interval and Density Forecasts of Exchange Rates with Time-Varying Parameter Models (2016). Bundesbank Discussion Paper No. 19/2016. Available at SSRN: https://ssrn.com/abstract=2801984

Angela Abbate (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
D-60431 Frankfurt/Main, DE Germany 60316
Germany

Massimiliano Marcellino

European University Institute ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

Villa La Fonte, via delle Fontanelle 18
50016 San Domenico di Fiesole
Florence, Florence 50014
Italy

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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