Working paper

Forecasting exchange rates of major currencies with long maturity forward rates

This paper presents unprecedented exchange rate forecasting results based upon a new model which approximates the gap between the fundamental equilibr

Publishing date
02 April 2020

The theoretical derivation of our forecasting equation is consistent with the monetary model of exchange rates. Our model outperforms the random walk in out-of-sample forecasting of twelve major currency pairs in both short and long horizons forecasts for the 1990-2020 period. The results are robust for all sub-periods with the exception of years around the collapse of Lehman Brothers in September 2008. Our results are robust to alternative model specifications, single equation and panel estimation, recursive and rolling estimation, and alternate data construction methods. The model performs better when the long-maturity forward exchange rate is assumed to be stationary as opposed to assuming non-stationarity. The improvement in forecast accuracy of our model is economically and statistically significant for almost all exchange rate series. The model is simple, linear, easy to replicate, and the data we use are available in real time and not subject to revisions.

JEL Classification: F31; F37

Keywords: exchange rate; error correction; forecasting performance; monetary model; out-of-sample; random walk

For further information please refer to the attached annex, downloadable here.

About the authors

  • Zsolt Darvas

    Zsolt Darvas, a Hungarian citizen, joined Bruegel as a Visiting Fellow in September 2008 and continued his work at Bruegel as a Research Fellow from January 2009, before being appointed Senior Fellow from September 2013. He is also a Senior Research Fellow at the Corvinus University of Budapest.

    From 2005 to 2008, he was the Research Advisor of the Argenta Financial Research Group in Budapest. Before that, he worked at the research unit of the Central Bank of Hungary (1994-2005) where he served as Deputy Head.

    Zsolt holds a Ph.D. in Economics from Corvinus University of Budapest where he teaches courses in Econometrics but also at other institutions since 1994. His research interests include macroeconomics, international economics, central banking and time series analysis.

  • Zoltán Zoltán Schepp

    Zoltán Schepp is a Hungarian citizen, based in Pécs, Hungary. He earned his PhD degree in Economics in 2004. He works at the Faculty of Business and Economics of the University of Pécs since 1991, where he became a full professor in 2018. He is the dean of the Economics School since 2015.

    His research is focused on international finance, including exchange rate forecasting, foreign currency borrowing and the uncovered interest rate parity puzzle, but he also investigates various aspects of higher education policy.

Related content