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.

Econometric models in foreign exchange market

According to the significance of the econometric models in foreign exchange market, the purpose of this research is to give a closer examination on some important issues in this area. The research covers exchange rate pass-through into import prices, liquidity risk and expected returns in the currency market, and the common risk factors in currency markets. Firstly, with the significant of the exchange rate pass-through in financial economics, the first empirical chapter studies on the degree of exchange rate pass-through into import in emerging economies and developed countries in panel evidences for comparison covering the time period of 1970-2009. The pooled mean group estimation (PMGE) is used for the estimation to investigate the short run coefficients and error variance. In general, the results present that the import prices are affected positively, though incompletely, by the exchange rate. Secondly, the following study addresses the question whether there is a relationship between cross-sectional differences in foreign exchange returns and the sensitivities of the returns to fluctuations in liquidity, known as liquidity beta, by using a unique dataset of weekly order flow. Finally, the last study is in keeping with the study of Lustig, Roussanov and Verdelhan (2011), which shows that the large co-movement among exchange rates of different currencies can explain a risk-based view of exchange rate determination. The exploration on identifying a slope factor in exchange rate changes is brought up. The study initially constructs monthly portfolios of currencies, which are sorted on the basis of their forward discounts. The lowest interest rate currencies are contained in the first portfolio and the highest interest rate currencies are in the last. The results performs that portfolios with higher forward discounts incline to contain higher real interest rates in overall by considering the first portfolio and the last portfolio though the fluctuation occurs.

A study on the effect of functional distribution of income on aggregate demand

In this thesis, we study the causal relationship between functional distribution of income and economic growth. In particular, we focus on some of the aspects that might alter the effect of the profit share on growth. After a brief introduction and literature review, the empirical contributions will be presented in Chapters 3,4 and 5. Chapter 3 analyses the effect of a contemporaneous decrease in the wage share among countries that are major trade partners. Falling wage share and wage moderation are a global phenomenon which are hardly opposed by governments. This is because lower wages are associated with lower export prices and, therefore, have a positive effect on net-exports. There is, however, a fallacy of composition problem: not all countries can improve their balance of payments contemporaneously. Studying the country members of the North America Free Trade Agreement, we find that the effect on export of a contemporaneous decrease in the wage share in Mexico, Canada and the United States, is negative in all countries. In other words, the competitive advantage that each country gains because of a reduction in its wage share (to which is associated a decrease in export prices), is offset by a contemporaneous increase in competitiveness in the other two countries. Moreover, we find that NAFTA is overall wage-led: the profit share has a negative effect on aggregate demand. Chapter 4 tests whether it is possible that the effect of the profit share on growth is different in the long run and in the short run. Following Blecker (2014) our hypothesis is that in the short run the growth regime is less wage-led than it is in the long run. The results of our empirical investigation support this hypothesis, at least for the United States over the period 1950-2014. The effect of wages on consumption increases more than proportionally compared to the effect of profits on consumption from the short to the long run. Moreover, consumer debt seem to have only a short-run effect on consumption indicating that in the long run, when debt has to be repaid, consumption depends more on the level of income and on how it is distributed. Regarding investment, the effect of capacity utilization is always larger than the effect of the profit share and that the difference between the two effects is higher in the long run than in the short run. This confirms the hypothesis that in the long run, unless there is an increase in demand, it is likely that firms are not going to increase investments even in the presence of high profits. In addition, the rentier share of profits – that comprises dividends and interest payments – has a long-run negative effect on investment. In the long run rentiers divert firms’ profits from investment and, therefore, it weakens the effect of profits on investment. Finally, Chapter 5 studies the possibility of structural breaks in the relationship between functional distribution of income and growth. We argue that, from the 1980s, financialization and the European exchange rate agreements weakened the positive effect of the profit share on growth in Italy. The growth regime is therefore becoming less profit-led and more wage-led. Our results confirm this hypothesis and also shed light on the concept of cooperative and conflictual regimes as defined by Bhaduri and Marglin (1990).

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.