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.

A distributed, compact routing protocol for the Internet

The Internet has grown in size at rapid rates since BGP records began, and continues to do so. This has raised concerns about the scalability of the current BGP routing system, as the routing state at each router in a shortest-path routing protocol will grow at a supra-linearly rate as the network grows. The concerns are that the memory capacity of routers will not be able to keep up with demands, and that the growth of the Internet will become ever more cramped as more and more of the world seeks the benefits of being connected. Compact routing schemes, where the routing state grows only sub-linearly relative to the growth of the network, could solve this problem and ensure that router memory would not be a bottleneck to Internet growth. These schemes trade away shortest-path routing for scalable memory state, by allowing some paths to have a certain amount of bounded “stretch”. The most promising such scheme is Cowen Routing, which can provide scalable, compact routing state for Internet routing, while still providing shortest-path routing to nearly all other nodes, with only slightly stretched paths to a very small subset of the network. Currently, there is no fully distributed form of Cowen Routing that would be practical for the Internet. This dissertation describes a fully distributed and compact protocol for Cowen routing, using the k-core graph decomposition. Previous compact routing work showed the k-core graph decomposition is useful for Cowen Routing on the Internet, but no distributed form existed. This dissertation gives a distributed k-core algorithm optimised to be efficient on dynamic graphs, along with with proofs of its correctness. The performance and efficiency of this distributed k-core algorithm is evaluated on large, Internet AS graphs, with excellent results. This dissertation then goes on to describe a fully distributed and compact Cowen Routing protocol. This protocol being comprised of a landmark selection process for Cowen Routing using the k-core algorithm, with mechanisms to ensure compact state at all times, including at bootstrap; a local cluster routing process, with mechanisms for policy application and control of cluster sizes, ensuring again that state can remain compact at all times; and a landmark routing process is described with a prioritisation mechanism for announcements that ensures compact state at all times.