n Annual Proceedings of the South African Statistical Association Conference - An extension of the traditional uncovered interest rate parity model for exchange rate forecasting

Volume 2019 Number Congress 1
  • ISSN :


Using a Principal Component Analysis (PCA) approach, we first investigate the sovereign yield spread term structure of the BRICS economies against that of the U.S. We show that the term structure for these markets are primarily driven by three latent factors which can be classified as the spread level, slope and curvature factors. We further postulate that a country’s yield curve contains valuable information about its future economic state and, as such, the PCA derived spread factors, which are based on the differences between sovereign yield curves, encapsulates material macro-economic information between the countries. In light of this, we show that augmenting the traditional Uncovered Interest Rate Parity model (UIRP) with these factors improves the model’s accuracy when forecasting exchange rate movements.

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