Title: Regime-specific exchange rate predictability and the role of uncertainty
Authors: Robinson Kruse-Becher - University of Cologne (Germany) [presenting]
Joscha Beckmann - University of Bochum (Germany)
Abstract: Exchange rates are notoriously difficult to predict. The benchmark findings that fundamental exchange rate models are unable to outperform naive benchmark forecasts has not been systematically overturned. The underlying reason is that predictability is strongly varying over time. Against this background, we contribute to the literature by analyzing whether regime-specific predictability can be traced back to specific highly persistent variables. We apply a threshold framework with two regimes, namely predictability and no predictability. This enables us to consider a model in which the switch between regimes is determined by an observable variable. In line with recent findings, we investigate several uncertainty and expectation measures as transition variables between the regimes of predictability and no predictability. Besides relying on established measures, we additionally obtain uncertainty from forecaster disagreement about real GDP, inflation, interest rates and the current account. Moreover, we extract yield curve factors. As exchange rate predictors for G10 currencies, we study persistent deviations from uncovered interest rate parity, purchasing power parity, the classical monetary exchange rate model and an asymmetric Taylor rule. Our findings suggest that various threshold effects are responsible for episodes of predictability with interest rate uncertainty being of special importance.