Affiliation:
1. Department of Economics and Business Economics Aarhus University Aarhus Denmark
2. Danmarks Nationalbank Copenhagen Denmark
3. Centre for Econometric Analysis and Faculty of Finance Bayes Business School (formerly Cass) London UK
Abstract
SummaryWe examine the relationship between exchange rates and macroeconomic fundamentals using a two‐step maximum likelihood estimator through which we compute time‐varying factor loadings. Factors are obtained as principal components, extracted from vintage macro‐datasets that combine FRED‐MD and OECD databases. Using 14 currencies over 1990–2021, we show that the loadings on the factors vary considerably over time and increase the percentage of explained variation in exchange rates by an order of magnitude. Time‐varying loadings improve the overall predictive ability of the model, especially during crises, and lead to better forecasts of sign changes in exchange rates.
Subject
Economics and Econometrics,Social Sciences (miscellaneous)
Cited by
1 articles.
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1. Exchange Rate Prediction Using Time Series Approach;Proceedings of Data Analytics and Management;2024