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Exchange rate predictability in emerging markets

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  • Baku, Elisa

Abstract

This paper uses financial and macroeconomic variables to predict currency returns, by using a two-step procedure. The first step consists of a cointegration equation that explains the exchange rate level as a function of global and domestic financial factors. The second step estimates an error-correction equation, for modeling the expected returns. This approach is a factor model analysis, where a Lasso derived technique is used for variable selection. This paper will focus on the five most frequently traded Latin American currencies, Brazilian Real (BRL), Chilean Peso (CLP), Colombian Peso (COL), Mexican Peso (MXN) and Peruvian Sol (PEN), during the time horizon from December 2001 until February 2016. The first finding is that the Global Exchange Rate Factor offers information about the exchange rate movements. In addition, this paper shows that commodity, equity prices and domestic risk premium are important variables for explaining exchange rates. Moreover, it confirms the existing results for the carry and slope variables.

Suggested Citation

  • Baku, Elisa, 2019. "Exchange rate predictability in emerging markets," International Economics, Elsevier, vol. 157(C), pages 1-22.
    • Handle: RePEc:eee:inteco:v:157:y:2019:i:c:p:1-22
    DOI: 10.1016/j.inteco.2018.06.003
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    Cited by:

    1. Raheem, Ibrahim, 2020. "Global financial cycles and exchange rate forecast: A factor analysis," MPRA Paper 105358, University Library of Munich, Germany.
    2. Ibrahim D. Raheem & Xuan Vinh Vo, 2022. "A new approach to exchange rate forecast: The role of global financial cycle and time‐varying parameters," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(3), pages 2836-2848, July.
    3. Múnera, Daimer J. & Agudelo, Diego A., 2022. "Who moved my liquidity? Liquidity evaporation in emerging markets in periods of financial uncertainty," Journal of International Money and Finance, Elsevier, vol. 129(C).
    4. José Luiz Rossi Júnior & Pedro Fontoura & Marina Rossi, 2023. "Are Global Factors Useful for Forecasting the Exchange Rate?," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 13(6), pages 1-14.
    5. Fredy Gamboa-Estrada & José Vicente Romero, 2022. "Common and idiosyncratic movements in Latin-American exchange rates," International Economics, CEPII research center, issue 171, pages 174-190.
    6. Abid, Abir, 2020. "Economic policy uncertainty and exchange rates in emerging markets: Short and long runs evidence," Finance Research Letters, Elsevier, vol. 37(C).
    7. Salisu, Afees A. & Olaniran, Abeeb & Tchankam, Jean Paul, 2022. "Oil tail risk and the tail risk of the US Dollar exchange rates," Energy Economics, Elsevier, vol. 109(C).
    8. Alfaro, Rodrigo & Goldberger, Natan, 2024. "FX-hedging for Latin American investors," Emerging Markets Review, Elsevier, vol. 59(C).
    9. Jaqueline Terra Moura Marins, 2024. "Predictability of Exchange Rate Density Forecasts for Emerging Economies in the Short Run," Working Papers Series 588, Central Bank of Brazil, Research Department.

    More about this item

    Keywords

    Exchange rates; Latin America emerging markets; Lasso; Error-correction; Factor model;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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