Exchange rate dependence and economic fundamentals: A Copula-MIDAS approach

Keywords Exchange rates; Economic fundamentals; Dependence; Mixed frequency; Copula Highlights * This paper evaluates the impacts of differences in economic fundamentals on exchange rate dependence by introducing the mixed-frequency copula model with a generalised autoregressive score dynamic structure. * In an application to the Canadian dollar, British pound and Japanese yen, the widened differences in money supply and interest rates tend to weaken exchange rate dependence, but the differences in output and inflation have no explanatory power for exchange rate dependence. * Investors are suggested to account for both daily exchange rates and monthly economic fundamental information in portfolio management. * The historical trends extracted from the economic fundamentals over the past 2 years enable investors to accurately predict exchange rate dependence and obtain additional economic benefits. Abstract The relationship between exchange rates is important for portfolio optimisation and risk management. Understanding the economic fundamentals that affect exchange rate dependence enables investors to improve their portfolio performance. This paper evaluates the impacts of differences in economic fundamentals on exchange rate dependence by introducing the mixed-frequency copula model with a generalised autoregressive score (GAS) dynamic structure. In an application to the Canadian dollar, British pound and Japanese yen, the widened differences in the money supply and interest rates tend to weaken exchange rate dependence, but the differences in output and inflation have no explanatory power for exchange rate dependence. Investors are suggested to account for both daily exchange rates and monthly economic fundamental information in portfolio management. In particular, the historical trends extracted from the economic fundamentals over the past 2 years enable investors to accurately predict exchange rate dependence and obtain additional economic benefits. Author Affiliation: (a) Department of Economics and Finance, SILC Business School, Shanghai University, Shanghai, China (b) School of Economics, Shanghai University of Finance and Economics, Shanghai, China (c) Key Laboratory of Mathematical Economics (SUFE), Ministry of Education, Shanghai 200433, China * Corresponding author at: School of Economics, Shanghai University of Finance and Economics, Room 524, School of Economics Building, 111 Wuchuan Road, Yangpu District, Shanghai 200433, China. Byline: Yuting Gong (a), Chao Ma (b), Qiang Chen [chen.qiang@mail.shufe.edu.cn] (b,c,*)