On the cross-sectional relation between exchange rates and future fundamentals |
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| Affiliation: | 1. University of Tunis, High Institute of Management, Tunis, Tunisia;2. College of Business Administration, AlBaha University, Saudi Arabia;3. Univ. Manouba, ESCT, RIM RAF, UR13ES56, Tunisia;4. University of Jeddah, College of Business, Department of Accounting, Jeddah, Saudi Arabia;5. University of Tunis, ISG, GEF-2A Lab, Tunis, Tunisia;6. University of Manouba, ESC, Manouba, Tunisia;1. European Commission, DG Joint Research Centre, Via Fermi 2749, I-21027, Ispra VA, Italy;2. Inter-American Development Bank, Calle 50 con Elvira Méndez, Tower Bank, Floor 23, Panama City, Panama;1. Department of Humanities and Social Sciences, Indian Institute of Technology Kharagpur, India;2. Indira Gandhi Institute of Development Research, Mumbai, India;1. Economic Research Institute for ASEAN and East Asia (ERIA), Indonesia;2. Keio University and Chief Economist at the ERIA, Indonesia;3. University of Technology, Sydney, Australia;1. Universidad Autónoma de Madrid, Spain;2. Universidad Complutense de Madrid, Spain;1. European University at St. Petersburg, 6/1A Gagarinskaya Str., St. Petersburg, 191187, Russia;2. Department of Economics, Feliciano School of Business, Montclair State University, Montclair, NJ, USA;1. University of Alcalá, Spain;2. University of Valladolid, Spain |
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| Abstract: | Using a cross-sectional perspective, we investigate the implications of the present-value model of exchange rates for a sample of 64 countries during 1971–2015, excluding periods of pegged exchange rates. Our paper uses all bilateral exchange rate pairs instead of choosing a reference currency and extends the list of fundamentals that have been examined in the previous literature by using the variables present in the behavioral equilibrium exchange rate (BEER) model. We document that exchange rates are strongly connected to future fundamentals using forecast horizons from one month to 10 years. Our findings highlight that unlike for time-series and panel data, the evidence against the “exchange rate disconnect puzzle” is more robust using a cross-sectional perspective. Given the relevance of fundamental factors in determining exchange rates dynamics we examine whether they are useful in constructing profitable investment strategies. Except for inflation, we find that a significant relation between exchange rates and a fundamental does not lead necessarily to a profitable investment strategy. Finally, we document that using the cross-rates of exchange rates leads to a significant improvement in the profitability of the carry trade strategy. |
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| Keywords: | Exchange rates Present-value model Economic fundamentals Forecasting Currency returns Carry trade F31 G10 |
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