Identifying Exchange Rate Common Factors

43 Pages Posted: 28 Aug 2017 Last revised: 30 Oct 2024

See all articles by Ryan Greenaway-McGrevy

Ryan Greenaway-McGrevy

University of Auckland Business School

Donggyu Sul

Independent

Nelson C. Mark

University of Notre Dame - Department of Economics and Econometrics; National Bureau of Economic Research (NBER)

Jyh-Lin Wu

National Sun Yat-sen University; National Chung Cheng University

Date Written: August 2017

Abstract

Using recently developed model selection procedures, we determine that exchange rate returns are driven by a two-factor model. We identify them as a dollar factor and a euro factor. Exchange rates are thus driven by global, US, and Euro-zone stochastic discount factors. The identified factors can also be given a risk-based interpretation. Identification motivates multilateral models for bilateral exchange rates. Out-of-sample forecast accuracy of empirically identified multilateral models dominate the random walk and a bilateral purchasing power parity fundamentals prediction model. 24-month ahead forecast accuracy of the multilateral model dominates those of a principal components forecasting model.

Suggested Citation

Greenaway-McGrevy, Ryan and Sul, Donggyu and Mark, Nelson Chung and Wu, Jyh-Lin, Identifying Exchange Rate Common Factors (August 2017). NBER Working Paper No. w23726, Available at SSRN: https://ssrn.com/abstract=3027830

Ryan Greenaway-McGrevy (Contact Author)

University of Auckland Business School ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Donggyu Sul

Independent

Nelson Chung Mark

University of Notre Dame - Department of Economics and Econometrics ( email )

442 Flanner
Notre Dame, IN 46556
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jyh-Lin Wu

National Sun Yat-sen University ( email )

70 Lien-hai Rd.
Kaohsiung 80424, Taiwan 80743
Taiwan
804 (Fax)

National Chung Cheng University

168 Univeristy Road
Ming-Hsiung, Chia-Yi, Taiwan 621
Taiwan

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