FORECASTING ASSET PRICES

UCLA Prof. Aaron Tornell

Economics 409 Winter 2023

This course must be taken jointly with the lab course Econ 447. Every week, the topics
covered in this course will have an applies counterpart in Ec447.

This is an in-person course. Lectures will not be synchronously streamed.

IN-PERSON ATTENDANCE IS REQUIRED TO OBTAIN PARTICIPATION POINTS.

Participation is 20% of the final grade.

COURSE OBJECTIVES
This is a hands-on course in which students will learn asset pricing mathematical models. They
will use these models to construct forecasts of exchange rates, stocks, bonds, and gold. To generate
forecasts students will (i) construct their own data sets of macroeconomic fundamentals, as well
as social media big-data sets, and (ii) code their filtering and forecasting algorithms. Students will
learn linear forecasting techniques, as well as non-linear techniques. Based on these forecasts,
students will construct portfolios and learn how to evaluate the portfolio’s profitability and risk
characteristics.

LEARNING OUTCOMES
Students will learn:
• How to derive dynamic equations that link asset prices with Macro fundamentals.
• How to apply time-series techniques, such as ARIMA and the Kalman filter.
• Machine learning techniques to generate forecasts.
• Econometric test to evaluate the accuracy of forecasts.
• How to construct portfolios and evaluate their risk characteristics.

GRADING
The course grade will be determined by:
Class participation (20%)
Homework (40%)
Final Project (40%)

EXTRA ACTIVITY HOURS

In addition to the lectures, there will be 3 hours per week of applied activities. Attendance to
these activities is voluntary and does not count for the final course grade. Meeting times:
Wednesdays 5pm – 8pm over Zoom: https://ucla.zoom.us/my/atornell
PARTICIPATION
Participation points will be obtained by answering quizzes during the class. To answer the
quizzes, a student must be present in the live-synchronous lecture. Quizzes cannot be answered
outside the classroom. During class, the instructor will provide a password to access the quiz.
The quiz will be available for a limited amount of time and should be submitted within 5
minutes. Every student is allowed to miss up to 2 quizzes during the quarter. That is, a student
may miss up to 2 quizzes and still get all participation points.

HOMEWORK
By the due date of each homework, please upload the solution on the homework submission link
(i.e., ‘Homework 1’). Each day of delay will subtract 25% of the corresponding homework’s
grade.

FINAL PROJECT
The logistics of the final project will be announced later in the quarter.

OFFICE HOURS
Weekly office hours will be posted in the class website. Also the tutor will have office hours during
which you may address clarifying questions regarding the class.

COMUNICATIONS
Administrative information regarding the course will be posted in the class website.

EMAIL POLICY
Please do not email with questions about the class material, homework, logistics, etc as I will not
be able to answer them. Instead, bring these questions to my and the Tutor’s office hours.

ACADEMIC INTEGRITY
Cheating is not allowed. Any cases of cheating—in exams, in quizzes, homework, projects—will
be reported to the Office of the Dean of Students. For more details on the policies on academic
integrity please refer to the Office of the Dean of Students website at
http://www.deanofstudents.ucla.edu/Academic-Integrity.

All students will be treated equally. No exceptions will be made.

MATERIAL
In the homework you will be asked to write simple code in order to develop your forecast strategy.
You may use any program of you prefer. In the lectures, I will use the software platform
Tradestation © which is useful to visualize and evaluate forecasts.

The Wall Street Journal and Barrons will be used in the course. You may subscribe to the WSJ
at a reduced rate for a few months or as a student also at a reduced rate at in www.wsj.com and
www.barrons.com

Alternatively, you may access the WSJ for free as follows:

A. Go to https://search.proquest.com/wallstreetjournal/advanced/
• Connect through the institution option by entering “UCLA”
• Log-in with your UCLA Id and Password
B. To access all the articles on a specific date, go to “Publications”
• Click “Wall Street Journal (Online); New York, N.Y.” (Includes all articles to present)
• You will be able to find any article under “Browse specific issues” by clicking your
desired year, month, and date.

TOPICS
The course consists of 20 Lectures, 2 per week.

W1

1. Momentum in Exchange Rates, Stocks and Bonds

2. Case Study: Momentum Portfolio Strategy
3. Paper: Moskowitz 2012
4. Evaluation of Portfolio Strategies: Compound RoR
5. Exchange Rates in the short run and UIP
6. Transitory Shocks and ERs

W2

7. Taylor Rule
8. Linear Forecasts using Taylor Rule
9. FOMC announcements & Exchange Rates
10. Case Study: Explaining the Yen movements in 2022
11. Evaluation of Portfolio Strategies: Sharpe Ratio
12. Diebold-Mariano and Clark-West tests
13. Paper: Moldstova & Papell (2008)
W3
14. Expected Future Shocks and Exchange Rates forecasting
15. Surprises and Exchanges Rate forecasts
16. The Kalman Filter and non-linear short-run Exchanges Rate forecasts
17. Case Study: Forecasting the Euro and Yen 2000-2022
18. Evaluation of Portfolio Strategies: Binomial forecast accuracy test
W4
19. Pricing of Bonds
20. Term Structure of interest rates
21. Futures markets forecasts of interest rates
W5
22. Pricing of Stocks
23. Evaluation of Portfolio Strategies: The Gini Coefficient

W6
24. Machine Learning and Nowcasting
25. Evaluation of Portfolio Strategies: Skewness

W7
26. The Forward premium puzzle and the Carry Trade
27. Exchanges Rate in the long run and PPP: The Real Exchange rate & the Big Mac
Index

W8
28. The Principle of Contrarian Opinion in Asset Prices

W9
29. Crypto Currencies & Digital Currencies

W10
30. Derivatives: Futures and Options
EXTRA ACTIVITY HOURS

In addition to the lectures, there will be 3 hours per week of applied activities. Attendance to
these activities is voluntary and does not count for the final course grade.
Meeting times: Wednesdays 5pm – 8pm
Over Zoom: https://ucla.zoom.us/my/atornell

Topics per Week

1) Economic Shocks in the USA and their effects on asset prices in 2019-2022
2) Discussion of the Barrons’ 2023 Roundtable
3) Discussion of the FED’s FOMC meeting of February 1, 2023 & Press conference
4) Discussion of the ECB Governing Council meeting of February 2, 2023 & Press conference
5) Economic Shocks in Japan and their effects on asset prices in 2019-2022
6) Economic Shocks in Europe and their effects on asset prices in 2019-2022
7) Economic Shocks in China and their effects on asset prices in 2019-2022
8) Discussion of Crypto and the FTX bankruptcy
9) Have News & consensus believes correctly forecasted asset prices? Contrarianism
10) Discussion of the FED’s FOMC & the ECB’s meetings of March 15 & 16, 2023

During each week, these activities will:

(i) Analyze how current news affects exchange rates, stocks and bonds
(ii) Drill deeper into the algorithms and models analyzed in class
(iii) Design Option strategies associated with the forecasts developed in class
(iv) Discuss newspapers financial articles
READINGS

Exchange Rate Determination

• Froot, Kenneth A. and Kenneth Rogoff. 1995. “Perspectives on PPP and Long-Run Real
Exchange Rates.” Handbook of International Economics Vol 3 Chapter 32
• Engel, Charles. 2014. “Exchange Rates and Interest Parity.” Handbook of International
Economics Vol 4 Chapter 8
• Taylor, John B. 1993. “Discretion versus Policy Rules in Practice.” Carnegie-Rochester
Conf. Ser. Public Policy 39: 195–214.
• Fama, Eugene F. 1984. “Forward and Spot Exchange Rates.” Journal of Monetary
Economics 14(3): 319-338.
• Gourinchas, Pierre-Olivier and Aaron Tornell. 2004. “Exchange Rate Puzzles and
Distorted Beliefs." Journal of International Economics 64(2):303-333.
• Eichenbaum, Martin and Charles L. Evans. 1995. “Some Empirical Evidence on the Effects
of Shocks to Monetary Policy on Exchange Rates.” Quarterly Journal of Economics
110:975–1009.
• Li, Ming and Aaron Tornell. 2015. “Exchange Rates Under Robustness: An Account of
the Forward Premium Puzzle.” Working Paper
• Hull, John C. 2014. “Options, Futures, and Other Derivatives.” Pearson.
• Bekaert, Geert J. and Robert J. Hodrick. 2011. “International Financial Management.”
Pearson.

Forecasts and Tests of Predictability

• Molodtsova, Tanya and David H. Papell. 2009. “Out-of-Sample Exchange Rate

Predictability with Taylor Rule Fundamentals.” Journal of International Economics 77:
167-180.
• Burnside, Craig, Martin Eichenbaum and Sergio Rebelo. 2011. “Carry Trade and
Momentum in Currency Markets.” NBER Working Paper No. 16942.
• Eichenbaum, Martin; Benjamin K. Johannsen; and Sergio Rebelo. 2018. “Monetary
Policy and the Predictability of Nominal Exchange Rates.
 • Engel C, and Wu, 2018, Liquidity and Exchange Rates.

• Kim, Hyo, Kim, Young Ju Kim, Zhipeng Liao and Aaron Tornell, 2019, “The Principle of
Contrarian Opinion and Its Implications for Forecasting Exchange Rates, mimeo.
• Pesaran, M. Hashem and Allan Timmermann. 1992. “A Simple Nonparametric Test of
Predictive Performance.” Journal of Business and Economic Statistics 10(4): 461-465.
• Diebold, Francis X. and Roberto S. Mariano. 1995. “Comparing Predictive Accuracy.”
Journal of Business and Economic Statistics 13(3):253-263.
• Clark, Todd E. and West, Kenneth D. 2006. "Using Out-of-Sample Mean Squared
Prediction Errors to Test the Martingale Difference Hypothesis," Journal of Econometrics
135(1-2):155-186.

Exchange rate forecasting using Social Media Data

• Azar and A. W. Lo. 2016, “The Wisdom of Twitter Crowds: Predicting Stock Market
Reactions to FOMC Meetings via Twitter Feeds,” SSRN
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2756815.
• Dautel, et al., 2020, Forex exchange rate forecasting using deep recurrent neural
networks, Digital Finance. https://dachxiu.chicagobooth.edu/download/ML.pdf
• P. Papaioannou, L. Russo, G. Papaioannou, and C. I. Siettos. 2013, “Can social
microblogging be used to forecast intraday exchange
rates?,” https://link.springer.com/article/10.1007/s11066-013-9079-3.
• V. Gholampour and E. Wincoop. 2017, “What can we Learn from Euro-Dollar
Tweets?,” NBER https://www.nber.org/papers/w23293.
• Daniel, Lawrence, Kim, and McKenzie. 2014, “The Efficiency of the Information
Processing in the Australian Dollar Market: Price Discovery Following Scheduled and
Unscheduled News,” SSRN
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2385223.
• Bulut. 2015, “Google Trends and the Forecasting Performance of Exchange Rate
Models,” SSRN https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2641796.
• Markiewicz, Verhoeks, Verschoor , and Zwinkels. “The Winner Takes it All: Measuring
Attention and Predicting Exchange Rates with Google Trends.”
 https://editorialexpress.com/cgi-
bin/conference/download.cgi?db_name=EEAESEM2018&paper_id=1982.
• Han, Xu and Yin, 2018. "Does investor attention matter? The attention-return
relationships in FX markets," Economic Modelling, Elsevier, vol. 68(C), pages 644-660
https://ideas.repec.org/a/eee/ecmode/v68y2018icp644-660.html.

OPTIONAL BOOKS

• Edwin Lefevre, 1923, Reminiscences of a Stock Operator, Wiley.

• Gerald Loeb, 1957, The Battle for Investment Survival, Media.
• Jack Schwager, 1992, The New Market Wizards, Harper.
• Gregory Zuckerman, 2019, The Man who Solved the Market: How Jim Simons Launched
the Quant Revolution, Penguin Random House.
• Krugman and Obstfeld, International Economics, Pearson.
• Gloria González-Rivera, 2012, Forecasting for Economics and Business, Routledge.