Exchange rates and macroeconomic fundamentals

Evidence of instabilities from time‐varying factor loadings

Bibliographic Data

ID21653602
AuthorsEric Hillebrand (0000-0002-8461-1671, Department of Economics and Business Economics Aarhus University Aarhus Denmark, corresponding author), Jakob Guldbæk Mikkelsen (Danmarks Nationalbank Copenhagen Denmark), Lars Spreng (Centre for Econometric Analysis and Faculty of Finance Bayes Business School (formerly Cass) London UK), Giovanni Urga (0000-0002-6742-7370, Centre for Econometric Analysis and Faculty of Finance Bayes Business School (formerly Cass) London UK)
Year2023
Volume38
Issue6
Pages857-877
Publication date2023-09-01
Open AccessYes
TypeARTICLE
VenueJournal of Applied Econometrics (JOURNAL)
Journal identifiersISSN: 1099-1255 • E-ISSN: 0883-7252
PublisherWiley (PUBLISHER • GB)
DOI10.1002/jae.2984
OpenAlexW4381325168
LanguageEN
Citations received1
References cited39

We examine the relationship between exchange rates and macroeconomic fundamentals using a two‐step maximum likelihood estimator through which we compute time‐varying factor loadings. Factors are obtained as principal components, extracted from vintage macro‐datasets that combine FRED‐MD and OECD databases. Using 14 currencies over 1990–2021, we show that the loadings on the factors vary considerably over time and increase the percentage of explained variation in exchange rates by an order of magnitude. Time‐varying loadings improve the overall predictive ability of the model, especially during crises, and lead to better forecasts of sign changes in exchange rates

Econometrics · Economics · Exchange rate · Monetary economics · Computer Science · Global Financial Crisis and Policies · Market Dynamics and Volatility · Monetary Policy and Economic Impact

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Open DOIOpen Access