Common Factors and the Exchange Rate: Results From the Brazilian Case

Authors

  • Jose Luiz Rossi Junior Insper Insituto de Ensino e Pesquisa
  • Wilson Rafael de Oliveira Felicio Insper Insituto de Ensino e Pesquisa

Keywords:

Exchange rates, Factor models, Out-of-sample forecasting

Abstract

This paper studies the usefulness of factor models in explaining the dynamics of the exchange rate Real / Dollar from January 1999 to August 2011. The paper verifies that the inclusion of factors embedded on the common movements of exchange rates of a set of countries significantly improves the in-sample and out-of-sample predictive power of the models comprising only macroeconomic fundamentals commonly used in the literature to forecast the exchange rate. The paper also links the information contained in the factors to global shocks as the demand for “dollars” – a dollar effect, volatility, and liquidity of global financial markets.

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Published

2014-04-01

Issue

Vol. 68 No. 1 (2014): Jan-Mar

Section

Articles

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