Forecasting Exchange Rates with Generalized Principal Components

Posted: 13 Oct 2017

See all articles by Karo Solat

Karo Solat

Virginia Tech

Kwok Ping Tsang

Virginia Polytechnic Institute & State University

Date Written: October 12, 2017

Abstract

We extract principal components from a panel of 17 exchange rates and use the deviations from the components to forecast future exchange rate movements, following the idea in Engel, Mark, and West (2015). Instead of using the standard method, we apply a generalized principal components analysis that captures temporal and cross-sectional variation and covariation among the exchange rates. We find that the method dominates forecasts by existing standard methods and random walk, with or without including macroeconomic fundamentals.

Keywords: factor model, principal component analysis, exchange rates, out-of-sample forecasting

JEL Classification: C53, F31, F47

Suggested Citation

Solat, Karo and Tsang, Kwok Ping, Forecasting Exchange Rates with Generalized Principal Components (October 12, 2017). Available at SSRN: https://ssrn.com/abstract=3051735 or http://dx.doi.org/10.2139/ssrn.3051735

Karo Solat

Virginia Tech ( email )

3021 Pamplin Hall
Blacksburg, VA 24061
United States

Kwok Ping Tsang (Contact Author)

Virginia Polytechnic Institute & State University ( email )

Blacksburg, VA 24061
United States

Register to save articles to
your library

Register

Paper statistics

Abstract Views
550
PlumX Metrics