Working Paper

Politics and exchange rate forecasts

Abstract: Standard exchange rate models perform poorly in out-of-sample forecasting when compared to the random walk model. We posit part of the poor performance of these models may be due to omission of political factors. We test this hypothesis by including political variables that capture party-specific, election-specific and candidate-specific characteristics. Surprisingly, we find our political model outperforms the random walk in out-of-sample forecasting at one to twelve month horizons for the pound/dollar, mark/dollar, pound/mark and the trade-weighted dollar, mark, and pound exchange rates.

Keywords: Foreign exchange rates; Political science;

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 1996

Number: 96-02