Point, Interval and Density Forecasts of Exchange Rates with Time-Varying Parameter Models

34 Pages Posted: 10 Oct 2016

See all articles by Angela Abbate

Angela Abbate

Deutsche Bundesbank

Massimiliano Giuseppe Marcellino

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: October 2016

Abstract

We explore whether modelling parameter time variation improves the point, interval and density forecasts of nine major exchange rates vis-a-vis the US dollar over the period 1976-2015. We find that modelling parameter time variation is needed for an accurate calibration of forecast confidence intervals, and is better suited at long horizons and in high-volatility periods. The biggest forecast improvements are obtained by modelling time variation in the volatilities of the innovations, rather than in the slope parameters. We do not find evidence that parameter time variation helps to unravel exchange rate predictability by macroeconomic fundamentals. However, an economic evaluation of the different forecast models reveals that controlling for parameter time variation and macroeconomic fundamentals leads to higher portfolios returns, and to higher utility values for investors.

Suggested Citation

Abbate, Angela and Marcellino, Massimiliano, Point, Interval and Density Forecasts of Exchange Rates with Time-Varying Parameter Models (October 2016). CEPR Discussion Paper No. DP11559, Available at SSRN: https://ssrn.com/abstract=2850401

Angela Abbate (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
D-60431 Frankfurt/Main, DE Germany 60316
Germany

Massimiliano Marcellino

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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