TY  - JOUR
AU  - Engel,Charles
AU  - Mark,Nelson C.
AU  - West,Kenneth D.
TI  - Factor Model Forecasts of Exchange Rates
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 18382
PY  - 2012
Y2  - September 2012
UR  - http://www.nber.org/papers/w18382
L1  - http://www.nber.org/papers/w18382.pdf
N1  - Author contact info:
Charles Engel
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706-1393
Tel: 608/262-3697
Fax: 608/262-2033
E-Mail: cengel@ssc.wisc.edu

Nelson Mark
Department of Economics
University of Notre Dame
434 Flanner
Notre Dame, IN  46556
Tel: 574/631-0518
Fax: 574/631-4783
E-Mail: nmark@nd.edu

Kenneth D. West
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706
Tel: 608/262-0033
Fax: 608/262-2033
E-Mail: kdwest@wisc.edu
AB  - We construct factors from a cross section of exchange rates and use the idiosyncratic deviations from the factors to forecast.  In a stylized data generating process, we show that such forecasts can be effective even if there is essentially no serial correlation in the univariate exchange rate processes.  We apply the technique to a panel of bilateral U.S. dollar rates against 17 OECD countries.  We forecast using factors, and using factors combined with any of fundamentals suggested by Taylor rule, monetary and purchasing power parity (PPP) models.  For long horizon (8 and 12 quarter) forecasts, we tend to improve on the forecast of a “no change” benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.
ER  -