I want to estimate/predict the volatility of the currency exchange rate. I have checked in literature a few models from very simple PPP to econometric factor model forecasting, to GARCH (for univariate), to DCC (dynamic conditional correlation for multivariate). Are there more suitable models? if yes may you mention them and indicate some references? Currently my choice would be to go for a factor model of the exchange rate because it seems to me a not too simple and not too complicated thing to implement. However I would like some advices. Thanks
Probably your best approach is to use something like a GARCH-X model. That gives you a GARCH setup to capture the persistence of volatility; however, you also bring in other exogenous-ish covariates to better model the mean and/or volatility. That would allow you to bring in (for example) the size of interest rate parity violations, PPP, change in PPP, productivity differences, and more.