meese rogoff redux
TRANSCRIPT
Meese-Rogoff Redux:Micro-Based
Exchange-Rate ForecastingBy MARTIN D. D. EVANS AND RICHARD K. LYONS
SHIEH AND HSIEH
International Economic
INTRODUCTION
• Present a micro-based model
• Compare with standard macro model and random walk
• Longer-horizon forecasting
• R.M & K.R.(1983)benchmark
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
INTRODUCTION
• Exchange-rate dynamics from expectational surprises
• Result that the micro-based model better
• Macro model will never explain exchange rate
• Not orthogonal to the evolving real economy
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
MEESE and ROGOFF 1983
S= 𝑎0 + 𝑎1 𝑚 − 𝑚 + 𝑎2 𝑦 − 𝑦 + 𝑎3 𝑟𝑠 − 𝑟𝑠 +
𝑎4 𝜋𝑐 − 𝜋𝑐 + 𝑎5𝑇𝐵 + 𝑎5 𝑇𝐵 + 𝑢
logarithm of the dollar price of foreign currency
logarithm of the ratio of the U.S. money supply to the foreign money supply
logarithm of the ratio of U.S. to foreign real income
short-term interest rate differential
expected long-run inflation differentia
cumulated U.S. and foreign trade balances
𝑟𝑠
𝜋
𝑦
𝑚
𝑠
𝑇𝐵
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
CONTENTS
1.Forecasting Exchange Rates
2.Forecasting 4 Models
3.Macro
4.Micro
5.Empirical Analysis
6.Conclusions
1.Forecasting Exchange Rates
Why are future changes in exchange rates so hard to forecast ?
𝑆𝑡 = (1 − 𝑏) 𝑖=0∞ 𝑏𝑖𝐸𝑡𝑓𝑡+𝑖 (1)
𝑆𝑡 Log nominal exchange rate
𝑏 Discount factor
𝐸𝑡
𝑓𝑡+𝑖 Current macro fundamentals
Exchange rate
Forecasting Exchange Rates
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Forecasting Exchange Rates
𝑆𝑡 = (1 − 𝑏) 𝑖=0∞ 𝑏𝑖𝐸𝑡𝑓𝑡+𝑖 (1)
𝑆𝑡 = 𝐸𝑡𝑓𝑡 +𝑏
1 − 𝑏𝐸𝑡∆𝑆𝑡+1
∆S𝑡+1 =1−𝑏
𝑏𝑆𝑡 − 𝐸𝑡𝑓𝑡 + 𝜀𝑡+1 (2)
𝑆𝑡 = E𝑡𝑓𝑡
𝜀𝑡+1 ≡ 1 − 𝑏
𝑖=0
∞
𝑏𝑖 E𝑡+1 − 𝐸𝑡 𝑓𝑡+𝑖+1 (3)
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
∆𝑓𝑡 = ∅∆𝑓𝑡−1 + 𝑢 (4)
𝑆𝑡 − 𝑓𝑡 = ∅ 𝑆𝑡−1 − 𝑓𝑡−1 +𝑏∅
1 − 𝛽∅𝑢𝑡
𝜀𝑡+1 =1
1 − 𝑏∅𝑢𝑡+1
∆𝑆𝑡+1=1 − 𝑏
𝑏(𝑆𝑡 − 𝑓𝑡 + 𝜀𝑡+1)
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Forecasting Exchange Rates
1 > ∅ > 0 𝑆𝑡 = E𝑡𝑓𝑡
2.Forecasting 4 Model
Marco or Micro ?
• UIP • Fama
• Micro1 • Micro2
∆𝑺𝒕+𝟏 = 𝒂𝟎 + 𝒂 𝒊𝒕 − 𝒊𝒕∗ + 𝜺𝒕+𝟏 ∆𝑺𝒕+𝟏 = 𝒂𝟎 + 𝒂 𝒊𝒕 − 𝒊𝒕
∗ + 𝜺𝒕+𝟏
∆𝑆𝑡+1 = 𝜌 + 𝑖𝑡 − 𝑖𝑡∗ + 𝜀𝑡+1 ∆𝑆𝑡+1 = 𝜂 0 + 1 − 𝜂 𝑖𝑡 − 𝑖𝑡
∗ + 𝜀𝑡+1
∆𝑺𝒕+𝟏 = 𝒂𝟎 + 𝒂𝑿𝒕𝑨𝑮𝑮 + 𝒆𝒕+𝟏
∆𝑺𝒕+𝟏 = 𝒂𝟎 +
𝒋=𝟏
𝟔
𝒂𝒋𝑿𝒋,𝒕𝑫𝑰𝑺 + 𝒆𝒕+𝟏
𝑎0 = 𝜌 , 𝑎 = 1 𝑎0 = 𝜂0 , 𝑎 = 1 − 𝜂
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
3.Macro Model
The Money-Income And Taylor model
1.the discount factor b is very close to unity
2. Information about future fundamentals arrives simultaneously
to all agents, who in turn revise their forecasts for fundamentals
in unison
Macro Models
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
𝑓𝑡 = 𝑚𝑡 −𝑚𝑡∗ − 𝑟 𝑦𝑡 − 𝑦𝑡
∗ + 𝑞𝑡 − 𝛼𝜌𝑡
𝑓𝑡 ≡ 𝑝𝑡 − 𝑝𝑡∗ −
1
𝜑0[𝜌𝑡 + 𝜑1 𝑦𝑡
𝑔− 𝑦𝑡
∗𝑔+ 𝜑2(𝜋𝑡 − 𝜋𝑡
∗)]
∆𝑆𝑡+1 → S𝑡 − 𝑓𝑡
∆𝑆𝑡+1 = 𝑖𝑡 − 𝑖𝑡∗ + 𝜌𝑡 + 𝜀𝑡+1
Macro Models
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
𝑖𝑡 − 𝑖𝑡∗ + 𝜌𝑡 =
1 − 𝑏
𝑏(𝑆𝑡 − 𝐸𝑡𝑓𝑡)
∆S𝑡+1 =1−𝑏
𝑏𝑆𝑡 − 𝐸𝑡𝑓𝑡 + 𝜀𝑡+1 (2)
∆S𝑡+1 = 𝑖𝑡 − 𝑖𝑡∗ + 𝜌𝑡 + 𝜀𝑡+1 (5) UIP
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Macro Models
∆𝑺𝒕+𝟏 = 𝒂𝟎 + 𝒂 𝒊𝒕 − 𝒊𝒕∗ + 𝜺𝒕+𝟏
𝑎0 = 𝜌 , 𝑎 = 1
∆𝑆𝑡+1 = 𝜌 + 𝑖𝑡 − 𝑖𝑡∗ + 𝜀𝑡+1
∆𝑺𝒕+𝟏 = 𝒂𝟎 + 𝒂 𝒊𝒕 − 𝒊𝒕∗ + 𝜺𝒕+𝟏
𝑎0 = 𝜂0 , 𝑎 = 1 − 𝜂
∆𝑆𝑡+1 = 𝜂 0 + 1 − 𝜂 𝑖𝑡 − 𝑖𝑡∗ + 𝜀𝑡+1
UIP Fama
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Macro Models
4.Micro Model
Aggregate order flow and Disaggregate order flow
𝑆𝑡 = (1 − 𝑏) 𝑖=0∞ 𝑏𝑖𝐸𝑡𝑓𝑡+𝑖 (1)
𝑆𝑡 Log nominal exchange rate
𝑏 Discount factor
𝐸𝑡𝑚
𝑓𝑡+𝑖 Current macro fundamentals
Expectations conditioned on market-marker’s information at t
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
A Micro-Based Model
S𝑡 = (1 − 𝑏) 𝑖=0∞ 𝑏𝑖𝐸𝑡
𝑚𝑓𝑡+𝑖 (7)
A Micro-Based Model
S𝑡 = (1 − 𝑏)
𝑖=0
∞
𝑏𝑖𝐸𝑡𝑚𝑓𝑡+𝑖
∆S𝑡+1 =1 − 𝑏
𝑏𝑆𝑡 − 𝐸𝑡
𝑚𝑓𝑡 + 𝜀𝑡+1𝑚
𝜀𝑡+1𝑚 ≡ (1 − 𝑏)
𝑖=0
∞
𝑏𝑖(𝐸𝑡+1𝑚 − 𝐸𝑡
𝑚)𝑓𝑡+𝑖+1
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
∆𝑆𝑡+1 = 𝑎0 + 𝑎𝑋𝑡𝐴𝐺𝐺 + 𝑒𝑡+1
∆𝑆𝑡+1 = 𝑎0 +
𝑗=1
6
𝑎𝑗𝑋𝑗,𝑡𝐷𝐼𝑆 + 𝑒𝑡+1
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
A Micro-Based Model
1. 1.Transactions flows must contain information relevant for fundamentals.
2. 2. If there is no delay because market-makers can observe aggregate order flow contemporaneously, then spot rates will be correlated contemporaneously with order flow
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
A Micro-Based Model
5.Empirical Analysis
Empirical analysis ─ Data
• End-user transaction flows
• Spot rate
• Euro deposit rate
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Empirical analysis ─Forecast comparisons• MSE
• Projection stat.
∆ℎ𝑠𝑡+ℎ 𝑡 the forecast of ∆ℎ𝑠𝑡+ℎ ≡ 𝑠𝑡+ℎ - 𝑠𝑡 on day “t”Step1 recursive h-period out of sample forecasts for non-RW model over the forecasting period
S→ T-h (i.e., ∆𝑠𝑡+ℎ 𝑡 for S < t ≤ 𝑇 − ℎ)
Step2 regress the forecasts on the realized value
∆ℎ𝑠𝑡+ℎ 𝑡 = 𝛽0 + 𝛽 ∆𝑠𝑡+ℎ + 𝑤𝑡+ℎ
Null hypothesis : 𝑠𝑡~RW
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Empirical analysis ─ Result
• MSE ratio is the ratio of mean squared forecast errors for the non-RW model to the RW model.
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
6.Conclusions
Conclusions
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Conclusions – Future work
• Is the forecasting power here coming from the real economy?
• If the dispersed information framework is the right one,what are the implications for deep issues?
• what degree is the information being revealed in order flow actually macroeconomic information?
Meese-Rogoff Redux : Micro-Based Exchange-Rate Forecasting
Thank you for your listening!