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Forecasting the daily exchange rate of the UK pound sterling against the US dollar

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  • Darvas, Zsolt
  • Schepp, Zoltán

Abstract

This paper is the first to use an economic theory-based model—the monetary model of exchange rates within a rational expectations present value framework—to forecast the daily exchange rate of a major currency. Our out-of-sample forecast evaluation period, spanning from 1990 to 2024, is longer than that of any other exchange rate forecasting study. We find that our model's forecasts outperform the random walk across all forecasting horizons, ranging from one day to five years. Moreover, a trading strategy based on our model's forecasts yields economically and statistically significant excess returns, surpassing those of the carry trade strategy.

Suggested Citation

  • Darvas, Zsolt & Schepp, Zoltán, 2025. "Forecasting the daily exchange rate of the UK pound sterling against the US dollar," Finance Research Letters, Elsevier, vol. 71(C).
    • Handle: RePEc:eee:finlet:v:71:y:2025:i:c:s1544612324014806
    DOI: 10.1016/j.frl.2024.106451
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    More about this item

    Keywords

    Currency trading; Exchange rates; Error correction; Forecasting; Monetary model; Out-of-sample; Random walk;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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