Forecasting exchange rates in the presence of instabilities

Many exchange rate papers articulate the view that instabilities constitute a major impediment to exchange rate predictability. In this thesis we implement Bayesian and other techniques to account for such instabilities, and examine some of the main obstacles to exchange rate models' predictive ability. We first consider in Chapter 2 a time-varying parameter model in which fluctuations in exchange rates are related to short-term nominal interest rates ensuing from monetary policy rules, such as Taylor rules. Unlike the existing exchange rate studies, the parameters of our Taylor rules are allowed to change over time, in light of the widespread evidence of shifts in fundamentals - for example in the aftermath of the Global Financial Crisis. Focusing on quarterly data frequency from the crisis, we detect forecast improvements upon a random walk (RW) benchmark for at least half, and for as many as seven out of 10, of the currencies considered. Results are stronger when we allow the time-varying parameters of the Taylor rules to differ between countries. In Chapter 3 we look closely at the role of time-variation in parameters and other sources of uncertainty in hindering exchange rate models' predictive power. We apply a Bayesian setup that incorporates the notion that the relevant set of exchange rate determinants and their corresponding coefficients, change over time. Using statistical and economic measures of performance, we first find that predictive models which allow for sudden, rather than smooth, changes in the coefficients yield significant forecast improvements and economic gains at horizons beyond 1-month. At shorter horizons, however, our methods fail to forecast better than the RW. And we identify uncertainty in coefficients' estimation and uncertainty about the precise degree of coefficients variability to incorporate in the models, as the main factors obstructing predictive ability. Chapter 4 focus on the problem of the time-varying predictive ability of economic fundamentals for exchange rates. It uses bootstrap-based methods to uncover the time-specific conditioning information for predicting fluctuations in exchange rates. Employing several metrics for statistical and economic evaluation of forecasting performance, we find that our approach based on pre-selecting and validating fundamentals across bootstrap replications generates more accurate forecasts than the RW. The approach, known as bumping, robustly reveals parsimonious models with out-of-sample predictive power at 1-month horizon; and outperforms alternative methods, including Bayesian, bagging, and standard forecast combinations. Chapter 5 exploits the predictive content of daily commodity prices for monthly commodity-currency exchange rates. It builds on the idea that the effect of daily commodity price fluctuations on commodity currencies is short-lived, and therefore harder to pin down at low frequencies. Using MIxed DAta Sampling (MIDAS) models, and Bayesian estimation methods to account for time-variation in predictive ability, the chapter demonstrates the usefulness of suitably exploiting such short-lived effects in improving exchange rate forecasts. It further shows that the usual low-frequency predictors, such as money supplies and interest rates differentials, typically receive little support from the data at monthly frequency, whereas MIDAS models featuring daily commodity prices are highly likely. The chapter also introduces the random walk Metropolis-Hastings technique as a new tool to estimate MIDAS regressions.

Radiogenic isotopes in the Mediterranean Sea: water mass exchange and precessional variability during the Messinian

During the late Miocene, exchange between the Mediterranean Sea and Atlantic Ocean changed dramatically, culminating in the Messinian Salinity Crisis (MSC). Understanding Mediterranean-Atlantic exchange at that time could answer the enigmatic question of how so much salt built up within the Mediterranean, while furthering the development of a framework for future studies attempting to understand how changes may have impacted global thermohaline circulation. Due to their association with specific water masses at different scales, radiogenic Sr, Pb, and Nd isotope records were generated from various archives contained within marine deposits to endeavour to understand better late Miocene Mediterranean-Atlantic exchange. The archives used include foraminiferal calcite (Sr), fish teeth and bone (Nd), dispersed authigenic ferromanganese oxyhydroxides (Nd, Pb), and a ferromanganese crust (Pb). The primary focus is on sediments preserved at one end of the Betic corridor, a gateway that once connected the Mediterranean to the Atlantic through southern Spain, although other locations are investigated. The Betic gateway terminated within several marginal sub-basins before entering the Western Mediterranean; one of these is the Sorbas Basin, a well-studied location whose sediments have been astronomically tuned at high temporal resolution, providing the necessary age control for sub-precessional resolution records. Since the climatic history of the Mediterranean is strongly controlled by precessional changes in regional climate, the aim was to produce records at high (sub-precessional) temporal resolution, to be able to observe clearly any precessional cyclicity driven by regional climate which could be superimposed over longer trends. This goal was achieved for all records except the ferromanganese crust record. The 87Sr/86Sr isotope record (Ch. 3) shows precessional frequency excursions away from the global seawater curve. As precessional frequency oscillations are unexpected for this setting, a numerical box model was used to determine the mechanisms causing the excursions. To enable parameterisation of model variables, regional Sr characteristics, data from general circulation model HadCM3L, and new benthic foraminiferal assemblage data are employed. The model results imply that the Sorbas Basin likely had a positive hydrologic budget in the late Miocene, very different to that of today. Moreover, the model indicates that the mechanism controlling the Sr isotope ratio of Sorbas Basin seawater was not restriction, but a lack of density-driven exchange with the Mediterranean. Beyond improving our understanding of how marginal Mediterranean sub-basins may evolve different isotope signatures, these results have implications for astronomical tuning and stratigraphy in the region, findings which are crucial considering the geological and climatic history of the late Miocene Mediterranean is based entirely on marginal deposits. An improved estimate for the Nd isotope signature of late Miocene Mediterranean Outflow (MO) was determined by comparing Nd isotope signatures preserved in the deeper Alborán Sea at ODP Site 978 with literature data as well as the signature preserved in the Sorbas Basin (Ch. 4; -9.34 to -9.92 ± 0.37 εNd(t)). It was also inferred that it is unlikely that Nd isotopes can be used reliably to track changes in circulation within the shallow settings characteristic of the Mediterranean-Atlantic connections; this is significant in light of a recent publication documenting corridor closure using Nd isotopes. Both conclusions will prove useful for future studies attempting to understand changes in Mediterranean-Atlantic exchange. Excursions to high values, with precessional frequency, are also observed in the radiogenic Pb isotope record for the Sorbas Basin (Ch. 5). Widening the scope to include locations further away from the gateways, records were produced for late Miocene sections on Sicily and Northern Italy, and similar precessional frequency cyclicity was observed in the Pb isotope records for these sites as well. Comparing these records to proxies for Saharan dust and available whole rock data indicates that, while further analysis is necessary to draw strong conclusions, enhanced dust production during insolation minima may be driving the observed signal. These records also have implications for astronomical tuning; peaks in Pb isotope records driven by Saharan dust may be easier to connect directly to the insolation cycle, providing improved astronomical tuning points. Finally, a Pb isotope record derived using in-situ laser ablation performed on ferromanganese crust 3514-6 from the Lion Seamount, located west of Gibraltar within the MO plume, has provided evidence that plume depth shifted during the Pliocene. The record also suggests that Pb isotopes may not be a suitable proxy for changes in late Miocene Mediterranean-Atlantic exchange, since the Pb isotope signatures of regional water masses are too similar. To develop this record, the first published instance of laser ablation derived 230Thexcess measurements are combined with 10Be dating.