On the Sources of Uncertainty in Exchange Rate Predictability

Byrne, Joseph P and Korobilis, Dimitris and Ribeiro, Pinho J (2014): On the Sources of Uncertainty in Exchange Rate Predictability.

Abstract

We analyse the role of time-variation in coefficients and other sources of uncertainty in exchange rate forecasting regressions. Our techniques incorporate the notion that the relevant set of predictors and their corresponding weights, change over time. We find that predictive models which allow for sudden, rather than smooth, changes in coefficients significantly beat the random walk benchmark in out-of-sample forecasting exercise. Using an innovative variance decomposition scheme, we identify uncertainty in coefficients estimation and uncertainty about the precise degree of coefficients' variability, as the main factors hindering models' forecasting performance. The uncertainty regarding the choice of the predictor is small.

• Item Type: MPRA Paper
• Language: English
• Keywords: Instabilities; Exchange Rate Forecasting; Time-Varying Parameter Models; Bayesian Model Averaging; Forecast Combination; Financial Condition Indexes; Bootstrap
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; F - International Economics > F3 - International Finance > F37 - International Finance Forecasting and Simulation: Models and Applications; G - Financial Economics > G0 - General > G01 - Financial Crises

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