Exchange Rates as Exchange Rate Common Factors

Abstract

Factor analysis performed on a panel of 23 nominal exchange rates from January 1999 to December 2010 yields three common factors. This paper identifies the euro/dollar, Swissfranc/dollar and yen/dollar exchange rates as empirical counterparts to these common factors. These empirical factors explain a large proportio no f exchange rate variation over time and have significant in-sample and out-of-sample predictive power.