Working Paper: CEPR ID: DP8045
Authors: Pasquale Della Corte; Lucio Sarno; Giulia Sestieri
Abstract: This paper examines the exchange rate predictability stemming from the equilibrium model of international financial adjustment developed by Gourinchas and Rey (2007). Using predictive variables that measure cyclical external imbalances for country pairs, we assess the ability of this model to forecast out-of-sample four major US dollar exchange rates using various economic criteria of model evaluation. The analysis shows that the model provides economic value to a risk-averse investor, delivering substantial utility gains when switching from a portfolio strategy based on the random walk benchmark to one that conditions on cyclical external imbalances.
Keywords: Foreign Exchange; Fundamentals; Global Imbalances; Predictability
JEL Codes: F31; F37; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in cyclical external imbalances (nxa) (F32) | future currency appreciation (F31) |
| decrease in cyclical external imbalances (nxa) (F32) | future currency depreciation (F31) |
| bilateral external imbalances (F32) | exchange rate returns (F31) |
| cyclical external imbalances (nxa) (F32) | exchange rate returns (F31) |
| cyclical external imbalances (nxa) (F32) | utility gains for risk-averse investors (D11) |