Explaining Exchange Rate Forecasts with Macroeconomic Fundamentals Using
Interpretive Machine Learning
- URL: http://arxiv.org/abs/2303.16149v1
- Date: Thu, 23 Mar 2023 04:40:23 GMT
- Title: Explaining Exchange Rate Forecasts with Macroeconomic Fundamentals Using
Interpretive Machine Learning
- Authors: Davood Pirayesh Neghab, Mucahit Cevik, M. I. M. Wahab
- Abstract summary: We develop a fundamental-based model for the Canadian-U.S. dollar exchange rate within an interpretative framework.
We propose a comprehensive approach using machine learning to predict the exchange rate and employ interpretability methods to accurately analyze the relationships among macroeconomic variables.
- Score: 1.1602089225841632
- License: http://arxiv.org/licenses/nonexclusive-distrib/1.0/
- Abstract: The complexity and ambiguity of financial and economic systems, along with
frequent changes in the economic environment, have made it difficult to make
precise predictions that are supported by theory-consistent explanations.
Interpreting the prediction models used for forecasting important macroeconomic
indicators is highly valuable for understanding relations among different
factors, increasing trust towards the prediction models, and making predictions
more actionable. In this study, we develop a fundamental-based model for the
Canadian-U.S. dollar exchange rate within an interpretative framework. We
propose a comprehensive approach using machine learning to predict the exchange
rate and employ interpretability methods to accurately analyze the
relationships among macroeconomic variables. Moreover, we implement an ablation
study based on the output of the interpretations to improve the predictive
accuracy of the models. Our empirical results show that crude oil, as Canada's
main commodity export, is the leading factor that determines the exchange rate
dynamics with time-varying effects. The changes in the sign and magnitude of
the contributions of crude oil to the exchange rate are consistent with
significant events in the commodity and energy markets and the evolution of the
crude oil trend in Canada. Gold and the TSX stock index are found to be the
second and third most important variables that influence the exchange rate.
Accordingly, this analysis provides trustworthy and practical insights for
policymakers and economists and accurate knowledge about the predictive model's
decisions, which are supported by theoretical considerations.
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