Advanced Search
MyIDEAS: Login to save this article or follow this journal

The out-of-sample success of term structure models as exchange rate predictors: a step beyond

Contents:

Author Info

  • Clarida, Richard H.
  • Sarno, Lucio
  • Taylor, Mark P.
  • Valente, Giorgio

Abstract

A large literature suggests that standard exchange rate models cannot outperform a random walk forecast and that the forward rate is not an optimal predictor of the spot rate. However, there is evidence that the term structure of forward premia contains valuable information for forecasting future spot exchange rates and that exchange rate dynamics display nonlinearities. This paper proposes a term-structure forecasting model of exchange rates based on a regime-switching vector equilibrium correction model which is novel in this context. Our model significantly outperforms both a random walk and a linear term-structure vector equilibrium correction model for four major dollar rates across a range of horizons.

(This abstract was borrowed from another version of this item.)

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/B6V6D-487CSG2-1/2/bf2456392cb2a04348c814612d85206b
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

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

Volume (Year): 60 (2003)
Issue (Month): 1 (May)
Pages: 61-83

as in new window
Handle: RePEc:eee:inecon:v:60:y:2003:i:1:p:61-83

Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/505552

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 231-254.
  2. Martin D. D. Evans and Richard K. Lyons., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance Working Papers, University of California at Berkeley RPF-288, University of California at Berkeley.
  3. Kilian, Lutz & Taylor, Mark P., 2003. "Why is it so difficult to beat the random walk forecast of exchange rates?," Journal of International Economics, Elsevier, Elsevier, vol. 60(1), pages 85-107, May.
  4. LeBaron, Blake, 1992. "Forecast Improvements Using a Volatility Index," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 7(S), pages S137-49, Suppl. De.
  5. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(5), pages 829-53, October.
  6. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
  7. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, Econometric Society, vol. 59(6), pages 1551-80, November.
  8. Meese, Richard A & Rose, Andrew K, 1990. "Nonlinear, Nonparametric, Nonessential Exchange Rate Estimation," American Economic Review, American Economic Association, American Economic Association, vol. 80(2), pages 192-96, May.
  9. Todd E. Clark & Michael W. McCracken, 1999. "Tests of equal forecast accuracy and encompassing for nested models," Research Working Paper, Federal Reserve Bank of Kansas City 99-11, Federal Reserve Bank of Kansas City.
  10. Garcia, R. & Perron, P., 1994. "An Analysis of the Real Interest rate Under Regime Shifts," Cahiers de recherche, Universite de Montreal, Departement de sciences economiques 9428, Universite de Montreal, Departement de sciences economiques.
  11. Bruce E. Hansen, 1995. "Erratum: The Likelihood ratio Test Under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Boston College Working Papers in Economics, Boston College Department of Economics 296., Boston College Department of Economics.
  12. Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
  13. Sarno, Lucio & Valente, Giorgio, 2002. "Comparing the Accuracy of Density Forecasts from Competing Models," Computing in Economics and Finance 2002, Society for Computational Economics 223, Society for Computational Economics.
  14. Charles Engel & Chang-Jin Kim, 1996. "The Long-Run U.S./U.K. Real Exchange Rate," NBER Working Papers 5777, National Bureau of Economic Research, Inc.
  15. West, K.D. & McCracken, M.W., 1997. "Regression-Based Tests of Predictive Ability," Working papers, Wisconsin Madison - Social Systems 9710, Wisconsin Madison - Social Systems.
  16. Boothe, Paul & Glassman, Debra, 1987. "The statistical distribution of exchange rates: Empirical evidence and economic implications," Journal of International Economics, Elsevier, Elsevier, vol. 22(3-4), pages 297-319, May.
  17. Naka, Atsuyuki & Whitney, Gerald, 1995. "The unbiased forward rate hypothesis re-examined," Journal of International Money and Finance, Elsevier, Elsevier, vol. 14(6), pages 857-867, December.
  18. Andrews, Donald W K, 1991. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Econometrica, Econometric Society, Econometric Society, vol. 59(3), pages 817-58, May.
  19. Charles Engel & Craig S. Hakkio, 1994. "The Distribution of Exchange Rates in the EMS," NBER Working Papers 4834, National Bureau of Economic Research, Inc.
  20. Jeffrey A. Frankel & Andrew K. Rose, 1994. "A Survey of Empirical Research on Nominal Exchange Rates," NBER Working Papers 4865, National Bureau of Economic Research, Inc.
  21. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics, Elsevier, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729 Elsevier.
  22. Meese, Richard A & Rogoff, Kenneth, 1988. " Was It Real? The Exchange Rate-Interest Differential Relation over the Modern Floating-Rate Period," Journal of Finance, American Finance Association, American Finance Association, vol. 43(4), pages 933-48, September.
  23. Taylor, Mark P, 1987. "Covered Interest Parity: A High-Frequency, High-Quality Data Study," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 54(216), pages 429-38, November.
  24. West, Kenneth D, 1996. "Asymptotic Inference about Predictive Ability," Econometrica, Econometric Society, Econometric Society, vol. 64(5), pages 1067-84, September.
  25. Saikkonen, Pentti & Luukkonen, Ritva, 1997. "Testing cointegration in infinite order vector autoregressive processes," Journal of Econometrics, Elsevier, Elsevier, vol. 81(1), pages 93-126, November.
  26. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  27. Diebold, Francis X & Gunther, Todd A & Tay, Anthony S, 1998. "Evaluating Density Forecasts with Applications to Financial Risk Management," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 863-83, November.
  28. Richard Meese & Kenneth Rogoff & Jacob Frenkel, . "The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification?," Working Paper 32044, Harvard University OpenScholar.
  29. Robert B. Davies, 2002. "Hypothesis testing when a nuisance parameter is present only under the alternative: Linear model case," Biometrika, Biometrika Trust, Biometrika Trust, vol. 89(2), pages 484-489, June.
  30. Richard H. Clarida & Mark P. Taylor, 1997. "The Term Structure Of Forward Exchange Premiums And The Forecastability Of Spot Exchange Rates: Correcting The Errors," The Review of Economics and Statistics, MIT Press, vol. 79(3), pages 353-361, August.
  31. Luintel, K. B. & Paudyal, K., 1998. "Common stochastic trends between forward and spot exchange rates," Journal of International Money and Finance, Elsevier, Elsevier, vol. 17(2), pages 279-297, April.
  32. Francis X. Diebold & James M. Nason, 1989. "Nonparametric exchange rate prediction?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 81, Board of Governors of the Federal Reserve System (U.S.).
  33. Mc Cracken, Michael W., 2000. "Robust out-of-sample inference," Journal of Econometrics, Elsevier, Elsevier, vol. 99(2), pages 195-223, December.
  34. Charles Engel, 1991. "Can the Markov switching model forecast exchange rates?," Research Working Paper, Federal Reserve Bank of Kansas City 91-04, Federal Reserve Bank of Kansas City.
  35. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, Elsevier, vol. 14(1-2), pages 3-24, February.
  36. Meese, Richard A & Rose, Andrew K, 1991. "An Empirical Assessment of Non-linearities in Models of Exchange Rate Determination," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(3), pages 603-19, May.
  37. Kilian, Lutz, 1999. "Exchange Rates and Monetary Fundamentals: What Do We Learn from Long-Horizon Regressions?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 14(5), pages 491-510, Sept.-Oct.
  38. John F. O. Bilson, 1980. "The "Speculative Efficiency" Hypothesis," NBER Working Papers 0474, National Bureau of Economic Research, Inc.
  39. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 385-423.
  40. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, December.
  41. Brown, Bryan W. & Mariano, Roberto S., 1989. "Predictors in Dynamic Nonlinear Models: Large-Sample Behavior," Econometric Theory, Cambridge University Press, vol. 5(03), pages 430-452, December.
  42. Richard K. Lyons, 2006. "The Microstructure Approach to Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 026262205x, December.
  43. Granger, C.W.J. & Pesaran, H., 1996. "A Decision_Theoretic Approach to Forecast Evaluation," Cambridge Working Papers in Economics 9618, Faculty of Economics, University of Cambridge.
  44. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, Elsevier, vol. 7(2), pages 151-174.
  45. Clarida, Richard H. & Sarno, Lucio & Taylor, Mark P. & Valente, Giorgio, 2003. "The out-of-sample success of term structure models as exchange rate predictors: a step beyond," Journal of International Economics, Elsevier, Elsevier, vol. 60(1), pages 61-83, May.
  46. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, American Economic Association, vol. 85(1), pages 201-18, March.
  47. Granger, Clive W J, 1986. "Developments in the Study of Cointegrated Economic Variables," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 213-28, August.
  48. Taylor, Mark P, 1989. "Covered Interest Arbitrage and Market Turbulence," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(396), pages 376-91, June.
  49. repec:cup:etheor:v:8:y:1992:i:1:p:1-27 is not listed on IDEAS
  50. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, Econometric Society, vol. 57(2), pages 357-84, March.
  51. Mark P. Taylor, 1995. "The Economics of Exchange Rates," Journal of Economic Literature, American Economic Association, vol. 33(1), pages 13-47, March.
  52. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  53. Saikkonen, Pentti, 1992. "Estimation and Testing of Cointegrated Systems by an Autoregressive Approximation," Econometric Theory, Cambridge University Press, vol. 8(01), pages 1-27, March.
  54. Harvey, David & Leybourne, Stephen & Newbold, Paul, 1997. "Testing the equality of prediction mean squared errors," International Journal of Forecasting, Elsevier, Elsevier, vol. 13(2), pages 281-291, June.
  55. Anthony Tay & Kenneth F. Wallis, 2000. "Density Forecasting: A Survey," Econometric Society World Congress 2000 Contributed Papers 0370, Econometric Society.
  56. Francis X. Diebold & Robert S. Mariano, 1994. "Comparing Predictive Accuracy," NBER Technical Working Papers 0169, National Bureau of Economic Research, Inc.
  57. Hans-Martin Krolzig, 1999. "Statistical Analysis of Cointegrated VAR Processes with Markovian Regime Shifts," Computing in Economics and Finance 1999, Society for Computational Economics 1113, Society for Computational Economics.
  58. 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, American Economic Association, vol. 80(4), pages 689-713, September.
  59. Johansen, Soren, 1995. "Identifying restrictions of linear equations with applications to simultaneous equations and cointegration," Journal of Econometrics, Elsevier, Elsevier, vol. 69(1), pages 111-132, September.
  60. Gallant, A Ronald & Rossi, Peter E & Tauchen, George, 1993. "Nonlinear Dynamic Structures," Econometrica, Econometric Society, Econometric Society, vol. 61(4), pages 871-907, July.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:inecon:v:60:y:2003:i:1:p:61-83. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.