GERAF Exchange Rate Model

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Written By
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Written By
Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.

The Global Exchange Rate Assessment Framework (GERAF) is a currency valuation model developed by the US Department of the Treasury to evaluate currency valuations. 

It looks at external imbalances and exchange rate misalignments by considering a wide set of economic indicators, structural factors, cyclical factors, and policy variables. 

GERAF gives a multilaterally consistent analysis, which allows for a detailed evaluation of the impact of both domestic and international policies on exchange rates.


Key Takeaways – GERAF Exchange Rate Model

  • US Treasury Dept Currency Valuation Model
    • Factors in macroeconomic fundamentals, policy variables, and structural and cyclical factors
  • Policy Impact
    • GERAF highlights how fiscal policies and foreign exchange interventions influence currency values.
  • Economic Indicators
    • Factors like productivity, trade balance, and GDP growth forecasts are important in predicting currency strength or weakness.
  • Risk and Stability
    • Safe asset indices and institutional stability can have roles in currency appreciation.


Value for Day Traders and Fundamental Currency Traders

Day Traders

GERAF offers day traders insights into the underlying economic factors that can influence short-term currency movements.

Understanding these fundamentals can help day traders understand/anticipate market reactions to economic data releases, policy announcements, and geopolitical events.

It helps put into perspective that there’s a lot that goes into asset price movements beyond a limited set of factors.

Fundamental Currency Traders

For traders focused on long-term trends, GERAF’s analysis of economic fundamentals, structural factors, and policy impacts provides a framework for assessing currency value.

By identifying potential misalignments and understanding the drivers of currency movements, fundamental traders can make better decisions about which currencies to pursue in their trading or avoid.

It can also improve strategic planning and risk management.


The Input Variables in the GERAF Framework

Cyclical Factors

Macroeconomic Fundamentals

  • Trade openness (exports + imports) / GDP
  • Net foreign assets (NFA) / GDP (lagged)
  • NFA / GDP * NFA debtor (lagged)
  • Relative output per worker
  • Real GDP growth (forecasted in 5 years)
  • Safe asset index

Structural Fundamentals

  • Old-age dependency ratio (OADR)
  • Population growth
  • Prime savers share
  • Life expectancy at prime age
  • Life expectancy at prime age * Future OADR
  • Institutional and political environment (ICGR-12)
  • Oil and natural gas trade balance * Resource temporariness

Policy Variables

  • Cyclically adjusted fiscal balance / GDP
  • Public health spending / GDP (lagged)
  • Foreign exchange intervention (FXI):
    • FXI / GDP
    • FXI / GDP * Capital account openness
  • Detrended private credit / GDP
  • Capital controls:
    • Relative output per worker * Capital account openness (lagged)
    • Demeaned VIX * Capital account openness (lagged)
    • Demeaned VIX * Capital account openness * Safe asset index (lagged)


How Each of the GERAF Model Variables Affects a Currency Value / Exchange Rate

Cyclical Factors

Output gap

An economy operating above potential (positive output gap) typically leads to higher inflationary pressures – which can be a bad thing – but it can also lead to higher interest rates.

Higher interest rates make a currency more attractive and valuable.

Conversely, a negative output gap can reduce currency value.

Commodity terms of trade gap

An improvement in commodity terms of trade (export prices relative to import prices) enhances national income and demand for the currency, thus increasing its value.

A deterioration has the opposite effect.

Macroeconomic Fundamentals

Trade openness (exports + imports) / GDP

Greater trade openness can improve currency value through increased foreign demand for domestic goods (and currency) + better resource allocation.

But it can also expose the economy to external shocks and potentially affect stability.

Net foreign assets (NFA) / GDP (lagged)

Higher NFA suggests a country is a net creditor. This can increase confidence and demand for its currency and boost its value.

Lower NFA or being a net debtor can decrease currency value.

NFA / GDP * NFA debtor (lagged)

This variable modifies the impact of NFA based on whether the country is a significant debtor.

High debt levels relative to GDP can weaken the currency due to repayment risks and potential default.

Relative output per worker

Higher productivity per worker indicates a more competitive economy.

This can potentially lead to stronger economic performance and currency appreciation due to higher demand for efficient and high-quality goods and services.

Real GDP growth (forecasted in 5 years)

Higher future GDP growth expectations typically increase investor confidence and attract foreign investment, which can lead to currency appreciation.

Lower growth expectations can have the opposite effect.

Safe asset index

A higher safe asset index indicates a currency and its government securities are viewed as safe havens.

Increased demand for safe assets during periods of global unknowns leads to currency appreciation.

Structural Fundamentals

Old-age dependency ratio (OADR)

A higher OADR suggests a larger proportion of dependents relative to the working population, potentially leading to lower economic growth and productivity, which can depreciate the currency.

Population growth

Higher population growth can increase economic output and potential growth, making the currency more valuable.

However, if not managed well, it can strain resources and infrastructure and possibly lead to currency depreciation.

Prime savers share

A higher share of prime savers (middle-aged individuals) typically leads to higher savings rates and investment, supporting economic stability and currency appreciation.

Life expectancy at prime age

Longer life expectancy at prime age reflects better health and productivity, contributing to economic growth and currency strength.

It also implies a potentially larger and more experienced workforce.

Life expectancy at prime age * Future OADR

This variable combines life expectancy with future old-age dependency, highlighting long-term sustainability.

Better prospects generally lead to currency appreciation, while higher future dependency ratios can have negative effects.

Institutional and political environment (ICGR-12)

Stronger institutions and stable political environments increase investor confidence, attract foreign investment, and enhance currency value.

Weak institutions and political instability can lead to currency depreciation.

Oil and natural gas trade balance * Resource temporariness

A positive trade balance in oil and natural gas boosts national income and currency value.

However, if resources are deemed temporary, it can limit long-term appreciation due to sustainability concerns.

Policy Variables

Cyclically adjusted fiscal balance / GDP

A higher (positive) fiscal balance suggests better fiscal health.

This can reduce borrowing needs and increase investor confidence, leading to currency appreciation.

Persistent deficits – especially those that aren’t funded and aren’t compensated with higher interest rate (i.e., money printing) – can weaken the currency.

Public health spending / GDP (lagged)

Higher public health spending enhances human capital and productivity, potentially strengthening the currency.

However, excessive spending without revenue support can lead to deficits and currency depreciation.

Foreign exchange intervention (FXI)


Active intervention to buy domestic currency can increase its value by reducing supply in the market.

Selling domestic currency can depreciate it.

FXI / GDP * Capital account openness:

The effectiveness of FXI depends on capital account openness.

In more open economies, interventions might be less effective due to greater capital flows, moderating their impact on the exchange rate.

Detrended private credit / GDP

Higher private credit availability can stimulate economic activity and strengthen the currency.

However, excessive credit growth can lead to financial instability and potential depreciation.

Capital controls

Relative output per worker * Capital account openness (lagged):

Higher productivity in a more open capital account regime can attract foreign investment and boost the currency.

Demeaned VIX * Capital account openness (lagged):

Higher market volatility (VIX) typically depreciates the currency in more open capital accounts as traders seek safer assets.

Demeaned VIX * Capital account openness * Safe asset index (lagged):

In times of high volatility, currencies with higher safe asset indices appreciate as they are considered safer investments, especially in open capital regimes.


How Would You Apply This in the Real World?

To apply the GERAF Exchange Rate Model in the real world:

Gather Data

Collect data for each input variable, such as output gap, trade openness, and net foreign assets, etc., for the countries and jurisdictions of interest.

Adjust Weightings

Experiment with different weightings for each variable.

Use historical data to backtest and refine the model, ensuring it accurately predicts past exchange rate movements.

Country-Specific Weightings

Recognize that the importance of each variable can vary between countries.

Adjust the weightings to reflect these differences, as economic conditions and policies are not uniform across nations.

Limited Testing

Implement the model in a limited way, testing its predictions on forward data to evaluate its performance.

This helps identify any adjustments needed for real-time application.

Incorporate Additional Factors

Acknowledge that the model doesn’t include all possible variables.

Continuously look for additional relevant data to improve the model’s accuracy.

We also covered how quants uncover hidden variables in a separate article.

Ensure Intuitive Logic

Be sure the model’s logic makes intuitive sense.

The relationships between variables and their impact on currency values should be clear and justifiable based on economic principles.

Effects aren’t always linear either.

By following these steps, you can develop a strong, adaptable exchange rate prediction model, leveraging GERAF’s framework while tailoring it to specific real-world conditions.