Which fundamentals drive exchange rates? A cross-sectional perspective

Sarno, L. & Schmeling, M. (2014). Which fundamentals drive exchange rates? A cross-sectional perspective. Journal of Money, Credit and Banking, 46(2-3), pp. 267-292. doi: 10.1111/jmcb.12106

[img]
Preview
PDF
Download (481kB) | Preview

Abstract

Standard present-value models suggest that exchange rates are driven by expected future fundamentals, implying that exchange rates contain information about future fundamentals. We test this key empirical prediction of present-value models in a sample of 35 currency pairs ranging from 1900 to 2009. Employing a variety of tests, we find that exchange rates have strong and significant predictive power for nominal fundamentals (inflation, money balances, nominal GDP), whereas predictability of real fundamentals and risk premia is much weaker and largely confined to the post-Bretton Woods era. Overall, we uncover ample evidence that future macro fundamentals drive current exchange rates.

Item Type: Article
Uncontrolled Keywords: Exchange rates, economic fundamentals, forecasting, present value model
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Finance
URI: http://openaccess.city.ac.uk/id/eprint/3406

Actions (login required)

View Item View Item

Downloads

Downloads per month over past year

View more statistics