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Forecasting the US Dollar-Korean Won Exchange Rate: A Factor-Augmented Model Approach

Author

Listed:
  • Sarthak Behera
  • Hyeongwoo Kim
  • Soohyon Kim
Abstract
We propose factor-augmented out of sample forecasting models for the real exchange rate between Korea and the US. We estimate latent common factors by applying an array of data dimensionality reduction methods to a large panel of monthly frequency time series data. We augment benchmark forecasting models with common factor estimates to formulate out-of-sample forecasts of the real exchange rate. Major findings are as follows. First, our factor models outperform conventional forecasting models when combined with factors from the US macroeconomic predictors. Korean factor models perform overall poorly. Second, our factor models perform well at longer horizons when American real activity factors are employed, whereas American nominal/financial market factors help improve short-run prediction accuracy. Third, models with global PLS factors from UIP fundamentals overall perform well, while PPP and RIRP factors play a limited role in forecasting.

Suggested Citation

  • Sarthak Behera & Hyeongwoo Kim & Soohyon Kim, 2020. "Forecasting the US Dollar-Korean Won Exchange Rate: A Factor-Augmented Model Approach," Auburn Economics Working Paper Series auwp2020-02, Department of Economics, Auburn University.
    • Handle: RePEc:abn:wpaper:auwp2020-02
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    File URL: https://cla.auburn.edu/econwp/Archives/2020/2020-02.pdf
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    More about this item

    Keywords

    Won/Dollar Real Exchange Rate; Principal Component Analysis; Partial Least Squares; LASSO; Out-of-Sample Forecast;
    All these keywords.

    JEL classification:

    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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