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Politics and exchange rate forecasts

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Author Info

  • Blomberg, S. Brock
  • Hess, Gregory D.

Abstract

Standard exchange rate models perform poorly in out-of-sample forecasting when compared to the random walk model. We posit part of the poor performance of these models may be due to omission of political factors. We test this hypothesis by including political variables that capture party-specific, election-specific and candidate-specific characteristics. Surprisingly, we find our political model outperforms the random walk in out-of-sample forecasting at one to twelve month horizons for the pound/dollar, mark/dollar, pound/mark and the trade-weighted dollar, mark, and pound exchange rates.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 43 (1997)
Issue (Month): 1-2 (August)
Pages: 189-205

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Handle: RePEc:eee:inecon:v:43:y:1997:i:1-2:p:189-205

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Web page: http://www.elsevier.com/locate/inca/505552

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References

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  1. Bachman, Daniel, 1992. "The effect of political risk on the forward exchange bias: the case of elections," Journal of International Money and Finance, Elsevier, vol. 11(2), pages 208-219, April.
  2. Rogoff, Kenneth & Sibert, Anne, 1988. "Elections and Macroeconomic Policy Cycles," Review of Economic Studies, Wiley Blackwell, vol. 55(1), pages 1-16, January.
  3. Westerfield, Janice Moulton, 1977. "An examination of foreign exchange risk under fixed and floating rate regimes," Journal of International Economics, Elsevier, vol. 7(2), pages 181-200, May.
  4. Chappell, Henry W, Jr, 1990. "Economic Performance, Voting, and Political Support: A Unified Approach," The Review of Economics and Statistics, MIT Press, vol. 72(2), pages 313-20, May.
  5. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  6. Frenkel, Jacob A. & Mussa, Michael L., 1985. "Asset markets, exchange rates and the balance of payments," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 14, pages 679-747 Elsevier.
  7. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  8. Jacob A. Frenkel & Michael L. Mussa, 1985. "Asset Markets, Exchange Rates and the Balance of Payments," NBER Working Papers 1287, National Bureau of Economic Research, Inc.
  9. Alesina, Alberto, 1987. "Macroeconomic Policy in a Two-party System as a Repeated Game," Scholarly Articles 4552531, Harvard University Department of Economics.
  10. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
  11. Francis X. Diebold & Marc Nerlove, 1986. "The dynamics of exchange rate volatility: a multivariate latent factor ARCH model," Special Studies Papers 205, Board of Governors of the Federal Reserve System (U.S.).
  12. Alesina, Alberto F & Roubini, Nouriel, 1990. "Political Cycles in OECD Economies," CEPR Discussion Papers 470, C.E.P.R. Discussion Papers.
  13. Meese, Richard, 1990. "Currency Fluctuations in the Post-Bretton Woods Era," Journal of Economic Perspectives, American Economic Association, vol. 4(1), pages 117-34, Winter.
  14. Gartner, Manfred, 1986. "Some political economy of flexible exchange rates," European Journal of Political Economy, Elsevier, vol. 2(2), pages 153-168.
  15. Ayanian, Robert, 1988. "Political Risk, National Defense and the Dollar," Economic Inquiry, Western Economic Association International, vol. 26(2), pages 345-51, April.
  16. Blomberg, S-B & Hess, G-D, 1995. "The Exchange Rate Politics Puzzle," Papers 95-14, Wellesley College - Department of Economics.
  17. Roubini, Nouriel & Alesina, Alberto, 1992. "Political Cycles in OECD Economies," Scholarly Articles 4553025, Harvard University Department of Economics.
  18. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  19. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-18, March.
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Citations

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Cited by:
  1. S. Brock Blomberg & Gregory D. Hess, 2000. "Is the political business cycle for real?," Working Paper 0016, Federal Reserve Bank of Cleveland.
  2. Helge Berger & Jan-Egbert Sturm & Jakob de Haan, 2000. "An Empirical Investigation into Exchange Rate Regime Choice and Exchange Rate Volatility," CESifo Working Paper Series 263, CESifo Group Munich.
  3. Gregory D. Hess & Mark E. Schweitzer, 2000. "Does wage inflation cause price inflation?," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Apr.
  4. John R. Freeman & Jude C. Hays & Helmut Stix, 1999. "Democracy and Markets: The Case of Exchange Rates," Working Papers 39, Oesterreichische Nationalbank (Austrian Central Bank).
  5. Todd E. Clark & Michael W. McCracken, 2000. "Tests of Equal Forecast Accuracy and Encompassing for Nested Models," Econometric Society World Congress 2000 Contributed Papers 0319, Econometric Society.
  6. S. Brock Blomberg, 2001. ""Dumb And Dumber" Explanations For Exchange Rate Dynamics," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 187-216, November.
  7. Meon, Pierre-Guillaume, 2001. "A Model of Exchange Rate Crises with Partisan Governments," Journal of Macroeconomics, Elsevier, vol. 23(4), pages 517-535, October.
  8. Daniel MITCHELL RESTREPO, 2006. "Forecasting the Colombian Exchange Rate: Capital Adjustments and Politics vs. Traditional IRP, Trade Adjustments and Random Walk Frameworks," ARCHIVOS DE ECONOMÍA 011228, DEPARTAMENTO NACIONAL DE PLANEACIÓN.
  9. S. Brock Blomberg & Jeffry Frieden & Ernesto Stein, 2005. "Sustaining fixed rates: The political economy of currency pegs in Latin America," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 203-225, November.
  10. Fratzscher, Marcel & Stracca, Livio, 2009. "Does it pay to have the euro? Italy’s politics and financial markets under the lira and the euro," Working Paper Series 1064, European Central Bank.
  11. Ernesto H. Stein & Jeffry Frieden & Piero Ghezzi, 2000. "Politics and Exchange Rates: A Cross-Country Approach to Latin America," Research Department Publications 3119, Inter-American Development Bank, Research Department.
  12. Iljoong Kim & Inbae Kim, 2005. "Endogenous changes in the exchange rate regime: A bureaucratic incentive model," Public Choice, Springer, vol. 125(3), pages 339-361, December.
  13. repec:onb:oenbwp:y::i:39:b:1 is not listed on IDEAS

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