Quantile Threshold Effects in the Dynamics of the Dollar/Pound Exchange Rate

Abstract

This article employs threshold quantile autoregressive models to study the dynamics in the American dollar / British pound exchange rate. We investigate whether the documented carry trade strategies developed by international investors can be fundamented in an apparent existence of predictability in the exchange rate. We extend the literature by estimating a threshold quantile autoregressive model which enables us to analyze the entire conditional quantile process instead of only the conditional mean. Our results show evidence of important heterogeneity associated with the returns on the dollar/pound exchange rate. These features of the data supporting predictability for some regimes are found, particularly, at moderate quantiles. The investment opportunities, however, vanish for extreme regimes within these quantiles, and also for extreme quantiles where the returns on exchange rates seem to be uncorrelated.